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Investing for Geeks (kalzumeus.com)
797 points by gk1 on Sept 16, 2016 | hide | past | favorite | 457 comments

Great post!!

I'd add a few things that I've learned over the years:

1) Always be invested in the market. Corollary, don't time the market. This is by far the largest mistake people make.

Investors typically pull money out at the bottom after they've suffered a physiologically devastating loss, like at the end of 2008 and hence they miss the rebound, like 2009-now. This isn't quite the same but it shows what missing the top 25 days in the market over the past 45 years does to your returns.


If you are an investor you need to be in the market, period.

2) Accept that you will lose money some years. If you are buying index funds then you will get market performance, ex fees. Markets go down sometimes. Stay the course.

3) Don't look every day or you will go nuts.

Keep in mind that the largest draw down (top to bottom) will be larger than what the returns look like if you just look year over year. Ie if you look and see the S&P lost 28% in 2008, understand that if you watched the S&P every day of 2008 then it probably lost more than 28% from its top to its bottom but rebounded slightly at the end of the year to make the year over year loss less than the maximum loss.

4) Have some exposure to outside of the US markets. Consider the scenario of investing all your money in the company you work for. In a rough time for your company you get the double whammy of losing money and possibly your job at the same time.

Similarly to how you are told to not invest all your money in the company you shouldn't invest solely in the country you live in, same principle.

EDIT see child comment, I mangled the English language in point 4

> Consider investing all your money in the company you work for.

Since that phrase is somewhat ambiguous, let me clarify for anyone who misunderstood it on first reading, like I did. :-)

I'm pretty sure you don't mean "It may be a good idea to invest all your money in the company you work for."

But rather "Consider this very bad thing that may happen if you invest all your money in the company you work for."


Yep, I really mangled that sentence. Sorry to everyone who just invested their life savings into the company they work for.

I guess I really meant...

> Consider the scenario of investing all your money in the company you work for.

Uggh, I wish I had read your comment before I just invested everything into the company I work for. Thanks chollida1.

I think he meant 'Reconsider...'

No, he meant "Think about, for a moment, the scenario..."

Immediate reaction: "Oh, like all those lucky people at Enron!"

I had to reread that sentence a couple of times myself, but I think you captured his intended meaning here.

> Have some exposure to outside of the US markets.

This is the part that kills my ability to "set it and forget it". So many things bother me about this. I know I have to do it (because Japan), but how much and on what markets?

* I don't like the idea of investing in emerging markets. Having grown up in one, I know how shady those can be and how cooked the books are. Growth is often an illusion. If an emerging market is "promising", I'd rather wait until it achieves developed status.

* Developed market indexes are dominated by Japanese stocks, which have gone nowhere in almost 3 decades. You have to accept that a good chunk of your money is going into a no-growth sink.

* I don't know what to expect from Europe. Or even Canada for that matter. When I look at those countries from a distance, I see that 1) their large corporations have been established looong ago (i.e. no new ones are created) and 2) heavy taxation and regulations in those countries doesn't seem to leave much room for profits, at least not as much as in the US. I'm probably wrong though, so please educate me.

I know home bias is supposedly wrong, but the American market is well studied, well known, highly liquid, and there's a cultural aspect to its growth in that its part of the general population's mindset to invest in it for long term goals. I don't think that's the case in all (or even most) countries.

Part of me wants to go full jlcollinsnh/Bogle/Buffet, folks who say you don't need international diversification. Another part of me wants to go as blind as possible into it and just invest in a "world index" ETF like ACWI or VT. And yet another part of me wants to do something in between but has no idea what to do :)

Well, that's why the original commenter mentioned exposure. You don't invest all your money into just one market. The idea is once again for things to balance out at the end of the day/year/decade.

Invest into multiple emerging markets, chances are they won't all do bad at the same time, especially if they are in different parts of the globe (take India, Brazil and Indonesia for example), put some into an european index fund, etc.

You seem to be most comfortable with the US market, so the bulk of the assets you decided to invest in equities go there, say 70% and to make things easy put 15% into Europe and 15% into emerging markets. Now you have some diversification, but could still feel comfortable enough to not be worried about your money disappearing over night.

Brazil is a disaster. In LA Chile has a quite stable economy and cautious banks (but it could be a pain to bring money into the country because of this).

Vanguard Target Retirement Funds. Pick the one that most closely corresponds to your anticipated year of retirement (or earlier, if you're conservative; later if you want to be aggressive). They will do all of the above for you.

Put your money into it. Walk away.

Actually, I've tried doing that. It worked for a while until one at I thought, "does Vanguard keep the course?" Turns out that when you look at it, they've made numerous "tweaks" throughout the years, and often bad calls. They definitely chase performance. Increased stock allocation right before the housing bubble crash. Increased international allocation when they saw it was performing well. Besides, they hold international currency-hedged bonds, something that no one seems to be able to come up with a good reason for.

> Turns out that when you look at it, they've made numerous "tweaks" throughout the years, and often bad calls... Increased stock allocation right before the housing bubble crash.

So what? If your target retirement date was 20+ years in the future, this is arguably the right call. If your retirement date was closer, they still more heavily weighted you toward safer assets.

The fact that they did this before a market crash is irrelevant — nobody can predict these things with any reliability. Not you, not me, not Vanguard.

> They definitely chase performance.

They definitely do not.

> Increased international allocation when they saw it was performing well.

Increased international allocation to track overall market better.

> Besides, they hold international currency-hedged bonds, something that no one seems to be able to come up with a good reason for.

From their website: The fund employs currency hedging strategies to protect against uncertainty in future exchange rates, so investment returns are expected to reflect the underlying performance of international bonds.

Appply same principle of buying and holding for 10+ years and get the Motley Fool Stock Advisor newsletter and buy their pics periodically. Excellent stock research.

I'm not in a position to know myself, but Patrick (author of the blog post that originally kicked off this discussion) does not think highly of The Motley Fool.

Hit this link: http://www.kalzumeus.com/2013/04/24/marketing-for-people-who... and search in the page for Motley Fool.

The only other data point I have to add is that a year or two ago, The Motley Fool published a breathless blog post announcing that 3D printing was about to destroy Chinese manufacturing, and that everyone should invest in companies that make 3D printers or CAD software.

My views on the Motley Fool are complicated.

They are a "diversified financial brand" which does a lot of e.g. telling people to get out of credit card debt (a good idea!) and save for retirement (a good idea!). Then they also tell people that "with just a little work, you too can read company numbers and outperform the stock market" (a really bad idea!) and "if you want to do less work, buy our newsletters and we'll give you picks which mumble mumble maybe mumble mumble will make you into Warren Buffet" (a really bad idea!).

I have a word of warning on Motley Fool. I once invested in a Chinese stock pick that they were promoting, and it shortly went to zero due to being fraudulent. Their research is often second hand and no better than the research you could do yourself.

Here's a simple illustration of why diversification is considered "good" in general. If you think of your portfolio as a weighted average of returns, the variance of the portfolio decreases as you add uncorrelated assets (i.e. diversify)[0]. In the simplest case, imagine two assets with the same expected return whose returns are uncorrelated. If you don't believe in stock-picking ability, diversifying between the two is a good idea. When you try to be more sophisticated about this, you get modern portfolio theory.

[0] https://en.wikipedia.org/wiki/Variance#Sum_of_uncorrelated_v...

I've invested comparatively little in emerging markets for the reasons in your penultimate paragraph plus the standard bogle/buffett advice. I definitely also have a nagging feeling that I could be very wrong about this strategy. For better or worse, I've viewed emerging markets in the same way that patrick views investing in startups: I have little reason to think/presume they will outperform the US markets on average, but I also couldn't successfully argue that they wouldn't.

The "trick" is probably to pay someone else to think about those problems by buying an international index fund like VXUS. If you're not comfortable with emerging markets, find one that excludes them

> Part of me wants to go full jlcollinsnh/Bogle/Buffet

You can investment just like Buffet if you Berkshire Hathaway Class B (BRKB). Currently ~$145 per share.

I got that from the introduction to an investment book about Buffet.

All these anecdotal quotes about Warren Buffett who issues bonds in Europe and didn't create Berkshire from index investing

His successful leveraged investments are analogous to negative expected value bets that people would typically relegate to degenerates.

He advocates indexing for the little people. This has nothing to do with what he did, or does now. (And there's nothing wrong with that)

Yes, he doesn't invest in indexes himself, but it isn't just for the little people. He recommends it for his family. The big secret to Buffet's success is not his picking ability, it is his management ability and good business sense. Yes, of course he does pick to an extent, but he also buys large enough positions to sit on the board and install the right people to make things happen. He also uses his already large portfolio to help create opportunities between the companies he owns.

It's unlikely even Buffet himself could replicate his initial stock picking success over a long period of time and he would be the first to admit that.

I don't see anything in the thread to suggest Berkshire was created from index investing. Someone just mentioned investing like Buffet.

What I meant was that he recommends that the average investor should invest in the S&P 500 or total US market only. He doesn't seem to think people should invest their money abroad.

There's a decent argument that American companies are multinational and therefore already exposed to foreign markets. I don't subscribe to that, but it's not totally unfounded.

That strategy would have lost out in the rise in uk stocks due to the drop in the pound

That rise only exists when you look at the ftse denominated in GBP not USD.

A lot of the FTSE 100 companies do look at how RDSB (Shell) Oil is denominated in $

Whatever you do, if you are a typical HN reader, do NOT invest like Buffet.

Hint: he never sells.

Berkshire files form 13F with the SEC that anyone can read.

He sells.

Serious question, when you're accumulating more assets and haven't retired yet, why is it a problem to never sell?

My expectation of a typical HN reader is that they are saving for more things/experiences/goals, not just retirement.

I'm curious why you would have that impression and why you think investing is the way to achieve those things.

Nothing saved for the short term should be in stocks. That would be an easy way to lose 30% of your vacation fund I'd you needed to sell on a dip.

Probably true, but I would also assume most readers are not putting all of their investments into one single fund for retirement.

I thought the Bogleheads usually do recommend intl exposure for us investors. Like, for a not-too-agressive balance, 40% total-stock-market, 40% intl, 20% bonds.

Vanguard recommends it, lots of folks on Bogleheads.org seem OK with it (they tend to recommend a three fund portfolio), but Vanguard founder Jack Bogle has said he thinks a two fund portfolio is sufficient because the US markets list big international companies rather than only those in the US.

In his Little Book of Common Sense Investing, Mr. Bogle recommends a simple portfolio of only two funds for many investors: Vanguard Total Stock Market Index Fund and Total Bond Market Index Fund:


I had similar biases and wasn't able to make a decision because of it, so eventually went with one of the robo advisors (Vanguard) for those reasons. While I don't like not having more control, letting others make decisions has essentially taken my bad behavior out of the equation.

FWIW Vanguard has about 35% allocated to international for me, so it's surprising to see that Bogle wouldn't recommend international exposure.

If you dont want to invest in emerging markets, its not the end of the world.

The risks can be higher but so are the rewards. The most important thing is to not just invest in a market blindly. Try your best to understand that market and keep tabs on that market.

You don't have to diversify for the sake for diversification. You can invest domestically and diversify by industries.

For the most part of the last 5 years, the risks have been higher and the words have been significantly lower than investing in the USA[0]: +75% versus -11%.

[0] https://www.google.com/finance?chdnp=1&chdd=1&chds=1&chdv=1&...

You don't need to invest in a foreign company to invest in a foreign market. Take a couple of US companies and see where their revenues come from geographically and diversify your holdings in that way.

Canada has less taxation than the US? Most of the banks have been around for a while, but haven't been this big until very recently.

> I don't know what to expect from Europe. Or even Canada for that matter...

Yeah, this is an over-generalization. There are plenty of index funds for European companies at a variety of risk levels, just like in the U.S.

Also, there are worldwide funds too. Capital World Growth and Income Fund (CWGIX) [0] is one example that covers the U.S., Europe, and Asia. Note that this is a mutual fund, not an index fund.

Edit: Perhaps the downvotes are because this is an actively managed fund. The point of giving the example was trying to counter the specific concern OP stated. For passive, a specific Vanguard fund that's similar, at least the closest I found, is Vanguard Total World Stock Index Fund (VTWSX) [1]. It is very diversified.

[0]: https://www.google.com/finance?q=MUTF:CWGIX

[1]: https://www.google.com/finance?q=MUTF:VTWSX

CWGIX is one of those front-end load and high-fee funds you should avoid, though.

Just edited it to point out that it is a mutual fund, not an index fund. Still over the past 5 years, it is +43% total.

S&P500 index funds are up 77% over the past 5 years. I would say that's kind of proving the point, except international indices have done poorly over that time period and I think that explains most of the difference. (VXUS is up only ~7% over the 5 year period.)

(All figures quoted above are "price" and ignore dividends, which is bad but I don't have easy access to dividends-included figures.)

Yeah, I think it'd be a more valid comparison to put it next to something someone would actually invest that's also international. I'm not sure if there is a similar Vanguard fund.

Edit: I think I found one — VTWSX is +35% over the same time period. Accounting for fees vs the managed fund, probably means a better return here.


This reminds me of when Fidelity did a survey to find which of their customers had portfolios that performed the best, and they found that the customers who were DEAD had the best performing portfolios: http://www.businessinsider.com/forgetful-investors-performed...

> "...No, that's close though! They were the accounts of people who forgot they had an account at Fidelity."

>Always be invested in the market.

Yes, I've heard that a million times, but that kind of advice presupposes a bull market. What if it's 1967, and you're about to go into a 15 year period of up and down markets, with no real growth in stock prices? And that's before inflation; the market fell substantially during the horrible 70s if measured in real dollars. All kinds of stock enthusiasts (like most folks here) got eaten alive. Pessimism reigned by the early 80s. Most people said "I'll never buy stocks again.".

Ironically, when investors finally capitulated, the great bull market of the 80s and 90s started.

My point is that most people here are mesmerized by that bull market, and by recent gains. But historically the indexes have had huge, long term swings that probably exceed most people's investment horizon.

"Past performance is no guarantee of future results" is not just a legal disclaimer. It's a bitter truth. Our current optimism is strongly colored by recent gains.

What if you had retired in 1929? You would have received nary a return for 25 years.

Sure, indexes average 8 percent or so, over the very long term, but it can be an intolerably long averaging interval.

> Yes, I've heard that a million times, but that kind of advice presupposes a bull market. What if it's 1967, and you're about to go into a 15 year period of up and down markets, with no real growth in stock prices? And that's before inflation; the market fell substantially during the horrible 70s if measured in real dollars. All kinds of stock enthusiasts (like most folks here) got eaten alive. Pessimism reigned by the early 80s.


> What if you had retired in 1929? You would have received nary a return for 25 years.

That just isn't true? You're looking at charts without dividends reinvested. Plug 1929-1950 into https://www.measuringworth.com/datasets/sap/ for example. It had bounced back above 1929 by 1937; never falls below the starting value after 1944.

I'll revise my position, but only slightly. Using the data that you pointed me at, if you had retired in 1929, you would have had to wait until 1944 before the market broke through permanently above the 1929 level, with dividends reinvested. So you would only have starved for 15 years, not 25.

Just because the market's down doesn't mean you can't spend retirement savings. You wouldn't need to starve (as someone wealthy enough to retire in 1929). Ideally you scale back your spending and look for work.

Social security was signed into law in 1935 (6 years later).

The problem isn't lasting the first 6-15 years (4% rule of thumb = 25x yearly spending; in very low risk cash/bonds obviously that lasts around 25 years), it's having any money left over to last the rest.

And keep in mind, 1929 and ~1965 are the two worst years to retire in in US history.

> "Past performance is no guarantee of future results" is not just a legal disclaimer. It's a bitter truth.

Definitely this. I personally believe "Always be invested in the market" is very irresponsible advice to give, precisely because it completely ignores this fundamental truth.

Just because markets have averaged a positive return in the past doesn't mean they necessarily will continue to average a positive return in the future. And as the saying goes, the market can remain irrational far longer than you can remain solvent.

That said, I still do invest most of my money in the market, but I don't try to pretend it's anything but a gamble. I've weighed my options, and the upside of investing in the stock market is much higher compared to all my other available options for investment, and I can afford to lose this gamble at this early stage in my life.

But when people ask me for investment advice, I will tell them it's a gamble and let them make that decision for themselves, rather than try to propagate this ridiculous urban myth that the stock market will always somehow eventually end up higher, and add fuel to what has essentially become a massive pyramid scheme.

2) this is a mind game, you are not actually loosing money in down years (unless you are actively trading), the market is just valueing your assets for less. When the market does this, you should see if prices are cheap, and if so buy as much as you can! - Warren Buffet style

> 1) Always be invested in the market. Corollary, don't time the market. This is by far the largest mistake people make.

The easiest way to tell if someone understands financial markets is to find out whether they believe they can time the market. If they believe they can predict the market, they don't know what they are talking about.

[edited - removed ending]

I like Patrick's restatement of the Practically Efficient Market Hypothesis:

You are astoundingly unlikely to know more about any stock from reading the newspaper, seeing their chart on Google Finance, or consuming their quarterly reports than a team of PhDs who did nothing but study that stock for the last year, and accordingly are vanishingly unlikely to trade stocks in such a fashion that you do better than the market once you account for fees and tax impact.

It gets to why these comment threads can sometimes have people talking past each other. Someone will say "You can't time the market", and mean 'you' in the same way Patrick does, but someone else will come along and think the statement meant "no one can time the market". Then the discussion goes off into a whole rabbit hole about quant hedge funds and the like.

Relating this back to techie-problems, perhaps we need the moderate Practically Secure Crypto Hypothesis:

"You are astoundingly unlikely to create something better and more-secure from seeing a blog-post, reading some Wikipedia articles, etc. than a team of PhDs who did nothing but study mathematical theory, cryptography, and code-breaking for the last few years, and accordingly are vanishingly unlikely to create a new scheme which is more secure than existing standards once you account for performance and maintenance."

Except that security standards are mostly driven by compatibility with all sorts of edge cases (ancient versions of software! COBOL-bound CAs! tiny smart cards! huge distributed systems!) that are probably not relevant to your case and create big random security holes.

If you have a reasonable way of distributing software updates, signed-DH with an AES-based AEAD with termination detection for transport authentication, and a signed hash tree for data authentication, is going to be more secure than RANDOM_SECURITY_STANDARD.

Thankfully, there are some good well-written implementations of that (https://www.tarsnap.com/spiped.html, https://nacl.cr.yp.to), but picking a standard randomly will not get you them.

I don't think that's always a case of people talking past each other. I will often reply to someone (in much the same way you just did) with a clarification about how some people do predict the market successfully, because even if I charitably assume they understand this implicitly, I want to make sure the literal idea that no one is capable doing it is not spread around like a gospel for other readers.

> There will likely be people that reply to this comment with various comments saying I am wrong. You can judge those comments for yourself.

This is the comment equivalent of a loaded question. Or it's like those people who dismiss those arguing against them because of who they are rather than what their argument is.

Good point, I edited that out.

While "If they believe they can predict the market, they don't know what they are talking about" is a cute adage, I think it lumps a bunch of us into a category that we don't deserve to be in?

for example, I'm heavily invested in the market but recent events are leading me to consider halfing my investment rate to be more cautious. I'm not going to take any money out or stop investing but by your def I'm "timing" the market, but really I'm "timing" my life. I don't feel confident that I can afford the risk, and I'm lowering my exposure rate.

If you are permanently lowering your exposure, you are not timing the market. If you are deciding that now the market is too hot and you don't like the risk, but plan on being invested later, you are timing the market.

I don't understand why I have to be permanently lowering my risk exposure. If Trump wins the election, the market will tank. Everyone knows this so lets say a 20% risk of him winning thus causing a 40% drop is currently priced in - the market right now is ~8% lower because of the risk of a Trump presidency. I am not willing to expose myself to that risk so just yesterday I moved my 401k out of the market. If Trump loses, the market will probably pop up but I am willing to forgo that gain to not expose myself to the downside.

The important point I haven't seen mentioned is that the money you put in the market should not be needed for 10 years. Not money you plan to buy a house in about 5 years, or maybe use to get married about 10 years from now. From 1929 to 1933 the DJIA went down 88% before starting to recover. Ten years is really too short a time horizon, you should have a 20 year perspective or longer. If you had invested the day before the 1929 crash and kept your money in the whole time you would not have broken even, adjusting for inflation, until 1957 - 28 years later.

You are market timing.

Yes I am. Trump will probably lose and I will have lower returns this year.

Would I be market timing if instead of moving out of the market to avoid the Trump winning risk, I borrowed money to buy shares in an election market?


If Trump wins, I triple the money I put into election shares but lose in my 401k. If Trump loses, the increase in my 401k will cover my loss in the election market.

I don't think you understand the basics of investing.

I laid out two strategies to hedge a specific, finite duration risk. Instead of an ad hominem attack, do you have any comments on either strategy?

What if trump loses and the market goes down?

What if trump wins and the market goes up, too? Things that "everyone knows" are already priced in.

Yup, exactly

There is something very off putting about your comment regarding how you preemptively dismiss anyone who would dare argue with you.

Time in the market beats timing the market - the adage is as old as time itself. Not sure that knowing it makes you understand the markets especially well. Similarly, not sure that not knowing it says anything about you either.

Knowing that adage doesn't mean you understand markets especially well, but not knowing it definitely means you don't understand markets.

I had a friend in college who played World of Warcraft. When the first expansion was announced, he invested $10,000 in Blizzard stock. His reasoning? "It's going to be awesome and sell a lot of copies!"

He didn't understand that the stock price at the time he made the purchase already reflected that information (that there was an expansion coming out soon).

Point taken. I edited it out.

And... just to go a step further. My comment included the word 'easiest' to describe how to find out someone doesn't know what they are talking about. IMO, if someone starts talking about timing the market, I know right away that they do not know what they are talking about.

Other indicators are much harder to diagnose. A self proclaimed market timer is just the easiest to identify.

So, if there was a massive crash in the stock market, you wouldn't be tempted to buy some shares at low prices?

I wouldn't think "in the market" meant only in stocks. When the stock market falls, other markets (like bond markets) tend to rise, which makes the bonds look like a poorer value and stocks look like a better value, therefore you would re-balance your exposure by selling some bonds and investing in the stocks

That's not always the case, just making the point that rebalancing a portfolio is not necessarily the same thing as trying to time a particular market.

Rebalancing the portfolio to other asset classes smells a lot like timing the market. The question still remains: When would you move to other asset classes?

You could see cash as a specific kind of market as well with your definition. I'm sure there were time periods when holding cash was your best option.

> Rebalancing the portfolio to other asset classes smells a lot like timing the market.

Rebalancing is not timing the market, unless you're changing your ratios.

Let's say I want 80% equities and 20% cash. The market bombs, and now I have 50% equities and 50% cash. If I thought all the information was already priced into the market, then reallocating to get back to 80/20 makes sense. Not rebalancing would be more like timing the market, because I would be assuming that the current value doesn't represent some "true value" of the market.

> The question still remains: When would you move to other asset classes?

Somewhat regularly, but not constantly because that takes time and has transaction costs. The specific time doesn't matter.

> I'm sure there were time periods when holding cash was your best option.

Definitely, it's just very very hard to identify which periods they are until after they've happened.

(Home currency) cash is essentially an ultra-short duration, zero yield (home government) bond.

Edit: Clarified that both are local.

No it's not. Currencies move against one another all the time. Your yield is only zero against the same currency, but it doesn't mean your yield is zero in terms of actual global buying power.

FOREX movement doesn't factor here? I'm talking about a single currency.

>The easiest way to tell if someone understands financial markets is to find out whether they believe they can time the market.

People also unwittingly imply have actions where, if you asked them, they'd say they couldn't predict the market, but they'll say things like "I'm waiting for the market to cool off"

I believe you can make money in trying to "time" the market, given you have good risk management in place. Nobody can predict the future all the time perfectly, but some educated predictions do come true sometimes. If the aim is to make money and not just trying to hold on to what you've got, you must take risks and that invariably comes down to "timing" the market.

> If you are an investor you need to be in the market, period.

This. Another way to think of it: if you are out of the market when it goes up by X% that is functionally equivalent to an X% loss, i.e. you have X% less money than you otherwise would have had.

(Well, OK, technically it's equivalent to a loss of X/(1+X) but that's pretty close to X for X<<100%.)

> Have some exposure to outside of the US markets.

The larger American companies are global companies, so you get that anyway. The proof is look what happens to the US markets when some foreign event happens, like Brexit.

Almost nothing happened to the US stock market on the day of Brexit.

Great advice. Given your background (I've really enjoyed reading your previous posts), what are your thoughts on the Bogleheads/Random Walk Down Wallstreet approach of sticking your cash in a couple varied funds, making regular contributions to dollar-cost average, and letting it sit?

Also, what are your feelings about various robo advisors like Wealthfront and Betterment and the competing products that Schwab and Vanguard have out now?

One minor, probably obvious, warning about dollar-cost averaging to new investors: commissions.

Say you have Fund A and Fund B set to automatically invest 50/50 your $100 dollar contribution bi-weekly, with a buy commission of $5. You pay buy commissions on fund A and B 4 total times a month, so you've wasted 10% of your monthly investment ability ($200 - $20). In a year that money is $194 at 8%. (This used to be the case with old ShareBuilder/ING/Capital One---not sure about the new-style other brokers)

Consider a monthly payment to Fund A and two weeks later a monthly payment to Fund B. You saved half commission cost of above, and in a year your return is ~$205.

You can avoid this with a Vanguard account that you use to buy Vanguard index funds. There are no commissions or service fees in that case.[1]

[1]: https://investor.vanguard.com/etf/fees

Same for Fidelity funds (or many iShares ETFs) in a Fidelity account.

Oh, cool I didn't realize that.

Most 401k plans are commission free (just a flat %)

The Bogleheads approach is the best approach for the normal investor. Stash it and forget it. Warren Buffett, considered the greatest investor of all time, highly recommends index funds to active investing.

Robo Advisors like Wealthfront are still just advisors, and that means they're just guessing like real-life advisors. And as has been proven time and again, they underperform index funds.

* http://www.investopedia.com/articles/investing/060216/3-reas... * http://finance.yahoo.com/news/buffett-most-mportant-investme...

No, Wealthfront and Betterment are not active fund managers. They invest your money in a variety of index funds and rebalance it often. Due to their hugely managed sums they can do a lot of tricks to try to improve your yield while still being broadly diversified.

The only trick they have is tax loss harvesting, which has limited effect (mostly due to $3,000/year limit on deducting). And you can do that by hand pretty easily.

They also reinvest dividends automatically, and rebalance automatically when you add new funds so you aren't over allocated in a particular class of assets.

Tax loss harvesting is limited to 3000 per year, but you can carry over until you've exhausted the losses.

Of course TLH is only good if you're in a taxable account with them.

I also don't buy it being easy- particularly with trying to avoid the pitfalls of wash sales and the paperwork to actually claim it.

> They also reinvest dividends automatically

Typical brokerages can do that too :-).

> rebalance automatically

The value of which is maybe dubious, as pointed out elsewhere in the thread. It doesn't need to be done frequently, if at all, and is pretty trivial with a simple 3-fund portfolio.

> Tax loss harvesting is limited to 3000 per year, but you can carry over until you've exhausted the losses.

Right. But you only get so many working years.

> Of course TLH is only good if you're in a taxable account with them.

> I also don't buy it being easy- particularly with trying to avoid the pitfalls of wash sales and the paperwork to actually claim it.

You need to be aware of how wash sales work even if you use a robo-advisor to do the TLH. You need to be sure you don't have substantially equivalent securities in your IRAs and 401(k), etc. The actual mechanic is pretty easy — sell one index fund (with shares held over 30 days), buy another extremely similar index (but not the exact same index).

As far as the paperwork — it's imported automatically with Turbotax etc and is exactly the same paperwork as is needed for capital gains.

TLH is also only good while you're working. If you have enough TLH saved up to cover the rest of your working years at $3k/year, you can stop paying the robo-advisor premium.

The problem many investors run into is that they do not like being referred to as "normal" or "average". This makes them susceptible to investing theses that lose money (ie. most of them other than Bogle style investing).

I think there is a place in the world for a company which simply minimizes risk for individual investors by alerting them of their factor exposures.

I'm sure there are people that are heavily invested in long duration bonds that do not understand how much interest rate risk they are taking.

Its a little different from a Robo advisor, but I'd probably pay 0.05%+ (5 basis points) annually to know my factor exposures.

I am likely exposed to factors that I am not even aware of.

I completely agree. It seems like the only way to currently get this information is through the robo advisors.

> And as has been proven time and again, they underperform index funds.

Hmm. Citation needed. They've barely been letting people invest long enough for that to be "proven" once, let alone "time and again".

There's references in the 2 Warren Buffett links

I'm not seeing references to robo advisors, or evidence to support that they underperform direct index funds in either of those two links.

I don't believe said evidence exists, here's why.

First, the robo advisors distribute your money directly against and amongst several index funds.

Second, the money-saving benefits robo advisors provide that direct indexing doesn't, like very frequent automatic rebalancing and automated (aggressive) tax-loss harvesting.

Third, the ability to diversify any amount of money. You can put $1k into Wealthfront and diversify across five Vanguard index funds. But directly on Vanguard, this is impossible because the minimum investment in most Vanguard funds is $3k [0].

With that, take their Total Stock Market Index Fund as an example. If you can only invest $3k in it, your expense ratio is 0.16% [1]. If you can invest $10k in it, your expense ratio is 0.05% [2]. Through Wealthfront, I can hold the VTI ETF at 0.05% expense ratio, which I don't have to pay directly, only indirectly out of the standard Wealthfront fees.

The best possible claim I can imagine then is that for very large accounts, excluding tax-loss harvesting benefits and any benefits of rebalancing, it is cheaper to index invest — for example, if you have a $100k account and can spend less than $225 worth of your time [4] in the entire year keeping up on it, rebalancing if you wish, etc., then in some cases you could beat the robos. The tradeoff of going direct is arguably not free though. I also don't believe this level of investment applies to most people, at least most Americans.

In fact, for accounts under $10k, the Wealthfront fee is zero. I can't think of a good reason why everyone shouldn't take advantage of that.

[0]: https://investor.vanguard.com/mutual-funds/fees

[1]: https://personal.vanguard.com/us/funds/snapshot?FundId=0085&...

[2]: https://personal.vanguard.com/us/funds/snapshot?FundId=0585&...

[3]: https://personal.vanguard.com/us/FundsSnapshot?FundId=0970&F...

[4]: https://www.wealthfront.com/our-low-fees

> evidence to support that they underperform direct index funds

Well, they charge additional fees. They have to make that up somewhere or it's the same (but at higher cost) as buying the indices directly.

> very frequent automatic rebalancing

This actually costs money and doesn't improve outcomes. Scroll to "study for the NYTimes on rebalancing" on http://johncbogle.com/wordpress/category/ask-jack/ . Or http://www.morningstar.com/cover/videocenter.aspx?id=615379 .

> automated (aggressive) tax-loss harvesting

Tax-loss harvesting has very limited benefit. Mostly you can offset income. But it's only $3k/year. You can harvest enough losses by hand to easily take the $3,000 deduction too.

> Third, the ability to diversify any amount of money. You can put $1k into Wealthfront and diversify across five Vanguard index funds. But directly on Vanguard, this is impossible because the minimum investment in most Vanguard funds is $3k.

No... you can buy the same Vanguard ETFs with no minimum.

> With that, take their Total Stock Market Index Fund as an example. If you can only invest $3k in it, your expense ratio is 0.16% [1]. If you can invest $10k in it, your expense ratio is 0.05% [2]. Through Wealthfront, I can hold the VTI ETF at 0.05% expense ratio

You can just buy VTI as an individual. You still get the 0.05% rate.

> The best possible claim I can imagine then is that for very large accounts, excluding tax-loss harvesting benefits and any benefits of rebalancing, it is cheaper to index invest — for example, if you have a $100k account and can spend less than $225 worth of your time [4] in the entire year keeping up on it, rebalancing if you wish, etc., then in some cases you could beat the robos.

Yeah. Reducing expenses is the goal.

> Yeah. Reducing expenses is the goal.

I feel like you may have overlooked some of the nuances in my answer, because I've already specifically pointed out how the robo advisors can be cheaper than buying the indexes directly for a lot of people.

> can be cheaper than buying the indexes directly for a lot of people.

If that's what you think, you've missed some of my post :-). Specifically, I said:

> you can buy the same Vanguard ETFs with no minimum.

As an individual you can get 0.05% VTI directly from Vanguard. No $3k minimum (minimums are a mutual fund thing).

While timing the market is a no go, from 2000, 2008, now 2016 it does seem we're at the peak again so it does not make much sense to invest in recent years? I stopped putting money into the stock market since a while ago due to this obvious trend/concern(interest rate has been zero for too long, stock has overrun the real economy, stock peaks after 8 years since 2008,etc)

>>While timing the market is a no go

>>I stopped putting money into the stock market since a while ago

These two statements are in conflict with one another. You are literally timing the market by not investing anymore. Just invest every month and you will be much better off.

> While timing the market is a no go, from 2000, 2008, now 2016

You realize you are trying to time the market, right?

The criticism here is silly.

There's a big difference between timing the market and looking at p/e ratios or debt load for stocks (or entire indexes) and deciding that they are way over valued. If you also think bond interest rates are too low likely to climb, hold your cash and come back to pick up stocks when they are cheaper. There's nothing wrong with that strategy as long as you are buying and selling on value and not trying to time a crash. Let the mob chase the yield down the rabbit hole.

If no one did this and everyone was just long everything forever, the market would be immediately broken.

edit: While I think John Bogle is a hero of the investment world with advice that all investors should heed, the Boglehead-Dunning-Kruger-effect can be profoundly annoying. They are a fantastic starting point and they address the most common mistakes, but it's a wee bit more complicated than Bogle's rules if you really want to learn equities and investing.

Are you forgetting about dividends?

The US Market 1981 to present is something of an anomaly that isn't likely to repeat. The same goes for the post WWII era. I'm not saying going long everything is a bad strategy necessarily, but like all investments, it's not guaranteed and has risks. There's nothing wrong with taking value into account when buying investments. It's very different from selling stock out of fear or because of a crash.

counterpoint: http://www.economist.com/blogs/buttonwood/2016/01/investing

Agree: timing the market is hard, but it's not impossible, particularly A) given that many big (institutional) investors are not at liberty to enter and exit (almost all mutual/index funds have prescribed what proportion must be in equities, say.) B) given that not all markets are as efficient as the EMH makes them out to be. For example, China fell precipitously from June 2015 ( http://www.bloomberg.com/quote/SHCOMP:IND ), and The Economist (AsiaPac edition) had a cover on 2015-05-30 proclaiming "China's overvalued stock market" ( http://www.economist.com/printedition/2015-05-30 )

To conclude, I think it is prudent to review your asset allocation maybe once or twice a year, and shift things around a bit.

Always be invested in the market but make sure that when you need the money that you have invested, it is there for you to spend. It doesn't make sense to keep in the money in the market when you know that you will be in loss when you will have to take it out.

> Always be invested in the market.

I'm glad you don't adhere to the defeatist approach of Efficient Market Hypothesis proponents. Always be in the market, yes. Always follow the market, no.

sorry, but "always be in the market" is a rule predicated on a period of history that's been especially kind to the good ole' usofa. there is absolutely no guarantee or even reason to believe in a guarantee of the same going forward.

here's something to think about, and i know i'll take downvotes to hell for all this: if everyone agrees and everyone is investing (for retirement etc) identically (long stocks bonds whatevers), what are the odds it's "cheap" or represents future extraordinary gains?

"Always be invested in the market" - what does it mean? Always have at least something long in your portfolio? Always be 100% long in your portfolio?

If I have 99% cash and 1% in VTI for 10 years, am I "always invested in the market" during this time?

Read Goldstein's (edit: Bernstein's!) book "If You Can".

It's a whopping 16 page book of plain talk and he made it free on the internet, no strings. [1] It's the best introduction to planning for retirement, especially for those under 35, I've read so far.

[1] https://www.etf.com/docs/IfYouCan.pdf

Bernstein :)

Reads like a fatherly chat with his children about personal finance, it's brilliantly written.

if you trust stocks and live in the US hat is, right?

Holy shit this is amazing. Thanks for this link. Helped tie together a bunch of scattered finance knowledge I've 'acquired' (or encountered in the wild I guess).

I agree with most of this, except for the stuff on robo-advisors. You should be very careful about those.

First of all their fees are too high. Wealthfront's 0.25% fee seems rather small and it is smaller than what a lot of human advisers charge, but if you compute it over a lifetime of savings with the negative compounding effect it will cost you a lot.

Imagine you receive some money when you are 20 from a rich uncle and invest it for 40 years using the wealthfront fee structure. After 40 years you will have paid about 10% of your savings in fees. Or, in other words, you will have about 10% more savings if you had taken a couple of hours to sit down and decide which funds to invest in. Keep in mind that the wealthfront fees are in addition of any etf or mutual fund fees you have to pay to get into investment vehicles.

So yeah, compounding interest is a dangerous thing.

There is another problem with roboadvisers -- people put too much trust in them. In our society there is this implicit trust of the computer, probably bred from multiple sci-fi shows with all-wise computers. Well it is a very dangerous thing when it comes to your savings.

You may not be the best investor, but you should take responsibility in your investment choices. You should know what you are investing in and why. Even if the thing you are investing in is a boring simple S&P 500 fund (as it should be for most of you) you should know what it is and why you are investing in it. You shouldn't just blindly follow some algorithm programmed by god-knows who.

This. The typical portfolio drummed up by roboadvisors corresponds to basically stone age portfolio theory. With a tiny amount of personal responsibility and education, you can replicate the same and net the difference in fees without spending your life thinking about finance to try to do better.

If you just want to 'set it and forget it', consider its an approach you're taking with the fruits of decades of your life.

[edit: typo]

The impression I get is that the two areas where robo-advisors shine is UX and Tax Loss Harvesting.

The Betterment site is pretty, which makes me more inclined to put more money into it more often. This is irrational, but for me this makes it worth more than the 0.15% I end up paying them in fees.

I'm less sure about whether TLH is worth the 0.15% fee, though. The premise is that you do some "equivalent" (to you, but not to the IRS) transactions, report them on your tax return, and lower the taxes you pay today ("basis"). In exchange, you would have to pay those taxes later on your investments when you withdraw them. Is this always the right answer (because those later taxes are in compounded-inflation dollars)? What if I think my tax rate now is lower than the tax rate in ten, twenty, fifty years?

Sort of. Ideally you're trading future long-term capital gains taxes for lower income tax today. You assume the future cap gains rate will be lower than or equal to your income tax today.

The amount I've already saved in tax dollars thanks to TLH is orders of magnitude higher than what I've paid Betterment in fees.

That being said, you won't always benefit from it, and there are caveats you should read about. I've decided to take a slightly more hands on but simpler approach, and have moved all of my investments into a simple 4-fund portfolio at Vanguard.

As you reach the $3k max and your portfolio continues to grow, the benefit to fee ratio becomes worse.

> Or, in other words, you will have about 10% more savings if you had taken a couple of hours to sit down and decide which funds to invest in.

If and only if you would have done about as well as the robo-advisor in those couple of hours. (I'm not saying this would or wouldn't happen, but it's pretty big for an unstated assumption.)

Well the thing is that the roboadviser is not even intended to make particular security picks. It is only supposed to decide which broad areas to invest in and what percentage for each area. Thus, the roboadviser can say that for your particular risk profile you should have 60% stocks 40% bonds and within the stocks you should have 60% sp500, 20% foreign large cap ... etc.

My point is this portfolio distribution stuff is not an exact science and there really isn't a right answer. There are some broad accepted guidelines, but they are rather broad and simple and you definitely do not need computers to follow them.

maybe you'll do better, maybe you'll do worse. the prevailing theory is that the expected value is the same (minus the fees). adding up years of fees, and suddenly you're short a nontrivial amount of money

This is true to some extent, although I have found that the automated "Tax Loss Harvesting" being offered by some roboinvestors more than pays for their percentage fee.

Should I also be performing the work of checking several times a year if I should be making sales, recording the losses, buying equivalent securities, and bundling that into a form for the IRS?

You are absolutely right on the fees being a problem here. I opened a wealthfront account a couple of years ago and added some money because I really liked the interface and I was sold on tax loss harvesting. I recently wanted to compare how my wealthfront account did compared to the S&P500 and I was surprised to see a 0.98 beta (almost the same monthly returns as S&P500) and an alpha of (-0.15 almost the fees they are charging) with very little r-squared error. Atleast for my risk profile (10), I would have been better off investing directly in S&P500. I didn't get high returns nor did I get reduced volatility with the wealthfront portfolio.

If you posit that all a robo-advisor does is "decides which funds to invest in" for you, how are you putting too much trust into a computer? A target-date fund from Vanguard also makes allocation choices for you across US/international stocks/bonds; is the conclusion that you should always invest in the underlying asset class directly instead of trusting a fund/advisor/company to do it for you?

One thing I very much dislike about many of the roboadivisors inculding Wealthfront, is their subjective take on what risk means.

Ex: Wealthfront's high risk portfolio back in 2013 had significant exposure to commodities -- mainly oil and metals. That sector has done poorly to say the least, and many a retail investor would not have correctly understood what Wealthfront's definition of risk actually meant.

If you're healthy enough to swing a high-deductible health plan, consider maxing out a "stealth IRA" aka health savings account. With a $3,350 individual / $6,750 contribution limit, it's a great tax-advantaged account that can be treated just like a Traditional IRA. If you use it for medical costs, which you are likely to have in retirement, you get tax advantage on both ends.


Agreed, if you have an HSA available it is probably the second places I would maximize contributions to, after a 401k/403b.

HSA contributions are arguably better considering they are not subject to FICA.

Yes, but only if they are deducted from your payroll by your employer, which is usually the situation when you have an HSA, but not always. You won't get a FICA refund if you contribute yourself off-payroll, but you will get an income tax refund at least.

As with all trustee-run plans, people should evaluate the investment options before moving the money in. The HSA I personally have access to is great for saving taxes on expenses, but if I wanted to use the investment options rather than sit in cash, my only options are high-fee managed funds (there's a lot less pressure on these vendors than on 401k trustees due to less public awareness)

Like an IRA, you're free to open an HSA with another provider and transfer the balance. You get the deduction from your employer and can invest in lower-fee funds. The best options are still relatively expensive compared to the IRA/401(k) scene, unfortunately.

It's like a traditional IRA, but the age for penalty-free non-healthcare withdrawals is higher (65 vs 59.5). Just something to keep in mind if you're older and think you might need the money sooner.

There is theoretically no time limit on taking withdrawals for medical expenses, so if you have enough medical expenses before you retire you can pay them with taxable money and withdraw in retirement those payments(save the receipts in case you get audited!). I wouldn't rely on that though, I'm sure the IRS will crack down on that if it becomes popular.

I don't see how the IRS would crack down on that unless the rules change. I don't see the rules changing without notice (time for people doing this to self-reimburse medical expenses before the rules change).

> You should open a SEP-IRA, which is a special account type that is similar to a 401k in mechanics but has very, very generous funding limits.

Actually, both account types have the same yearly limit; it's just that the employer can contribute much more than the employee, and when self-employed you can contribute as the employer.

In fact, the difference between SEP IRA and 401k is not the funding limits, but the fact that the SEP IRA allows only employer contributions. You can actually open a "solo 401k" for yourself if you are self-employed, and make both employer and employee contributions. That will let you put more money away for a given income than the SEP IRA, until you make 275k or so at which point you have hit the cap for both (and the cap is the same for both).

Edit: Vanguard has a calculator to show the difference:


This is exactly right, although with solo 401k, you can hit the cap of $53k contributions with net profit of only ~$185k, not $275k, if you max both employee and employer contributions.

Additionally, with a solo 401k plan, the $18k employee contributions can be Roth.

Ah, good point about the Roth contributions! I'd forgotten about that difference.

> Often when I told people I was building a (toy) stock exchange they’d ask me for stock advice, which is about as well-considered as asking a WoW guild to deal with your terrorism problem.

And you think that's problematic? I have relatives telling me that they'll go with X anti-thrombotic therapy because a cousin of the brother of a guy who they met in the supermarket took it 6 years ago and worked wonders for him. I'm a pharmacist and I have rather strong opinions about some drugs over others, but I can take advices from doctors, physicians, nurses or anyone with a minimum degree of knowledge on the topic. Still, many times I have to argue with with relatives, to the point where I get frustrated.

Question - is it fair to use the 8% historical market average when doing these calculations (which include some of the most spectacularly productive periods in the American economy)? All the predictions I've seen going forward look like the average will be much lower (at least for the current generation), and a rate of 4-5% means you need a much larger nest egg to drawdown a livable amount each year in retirement.

Edit: It's not clear from the essay, but I'm assuming Patrick's 8% rate is not adjusted for inflation (based on his 40k drawdown scenario - the other 3-4% would cover inflation).

It's ridiculously high. For a better evaluation, see probably one of my favorite visualizations of all time:


I feel this graphic, while informative and delightful, is insidious in its choice of scale and its lack of comparisons.

On scale, it makes it seem like +3% to +7% real returns is "neutral". This makes it seem like the stock market is sometimes good sometimes bad but overall it may as well be just okay.

On comparisons, it does a huge disservice by not adding a tab showing bond yields and a tab showing cash/treasury yields (which would be dark red across the board except light red around 1930).

I feel these slights make the graphic present stock investing in an unfairly unfavorable light and makes the suboptimal strategy of keeping your money out of the market seem much more favorable than it is.

The graphic isn't presented to compare stocks with the alternatives of cash/bond yields. I think the major service done here is setting a realistic expectation for the returns you might see in your lifetime. It's especially relevant for people who's major investing periods have/will occur in the 2000-2020 timeframe of sluggish growth and ultra-low yield. The Jeremy Siegel '8%' number is a really dangerous number to set your expectations on when saving. If you do, you might be 20 years in and well outside the bounds of a timeframe where compound interest can help you live the retirement you were aiming for before you realize your mistake.

Agreed. That horribly misleading graphic mislead me for a long time as a child.


This single diagram explains the market dynamic year over year in a way I've never seen anywhere else. The 1/3/5/10 yr returns figures you see don't even come close to understanding the nuances of one year over another.

I remember when this diagram was published in 2011 and _still_ refer to it routinely.

This is why you do dollar cost averaging and steadily invest every year, to spread out your investments over multiple years.

I'm glad you like it but I don't follow how you infer dollar cost averaging from this. There's no statistical advantage to dollar cost averaging over lump sum investing (actually the opposite due to the median return beating inflation). I'd argue the main benefit is a realistic expectation and understanding of the range of returns to help you plan better.

Dollar cost averaging doesn't have a better expected value than lump sum investing, but it should have a lower variance, no?

Also, there's dollar cost averaging like "I have a lump sum now, but I will invest it slowly over the next 2 years" and there is dollar cost averaging like "I will invest money as it comes in slowly over the next 2 years instead of saving it up and investing it as a lump sum then". The former is the technical definition, but the latter is what most people mean when they use the term informally...

I think it's ridiculously high. I have a running calculation where I figure the APY of all my 20+ years of retirement contributions, had I immediately put my contributions into an S&P-500 fund. It uses "adjusted close" prices, so it takes dividends into account.

Right now it is at 7.6%. It is not inflation adjusted, so it's lower in real terms. Also, for the great majority of those 20 years, the APY was much lower. And, since most advice says to do some mix of domestic, international, and bonds, most ideal portfolios will have even lower performance.

I know it's just one data point, but one reason this is lower than expected is because people tend to have more money to put into the market when times are good (and the market is high), and less money to put into the market when times are bad (and the market is low). It was true for me in terms of my contribution history, at least.

It's not ridiculously high. He looked at a 10 year window, and you are looking at a 20 year window. 10 year windows show more volatility.

And if you're concerned about "one data point", I'll give you plenty:


For a 20 year window, it's below 6% inflation adjusted, and close to 8% without taking into account inflation (closer to your 7.6% figure)

Personally, no, I don't think it is fair assumption.

US GDP growth has been slowing for decades now. At some point that will be reflected in the markets and the index funds that track them.


(But, yes, I still invest in index funds. I just don't have the same dreamy expectations that many other people seem to have.)

We've also had some spectacularly high inflation in the past, which tempers those GDP numbers somewhat. I otherwise agree that historical norms for equity market returns are probably overly optimistic for the future, but I wouldn't be extremely pessimistic either.

That growth rate is real, not nominal.

So it is. It isn't very clear looking at that chart though, unfortunately. Another reason why I prefer FRED for this kind of data [1].

1. https://fred.stlouisfed.org/series/A191RL1A225NBEA

No, it is not fair. If you look at the global stock market (which is 'the market' as such) the returns have not been that high. 8% is based on a nation that has indeed done exceptionally well. If you look at current P/E ratios and dividend yields it is almost impossible we would see that as a consistent average going forward. Also look at bond yields: very very low - so a balanced portfolio will do less well, too.

It's got to be too high. As someone who has survived two steep market corrections and have been in and out of the market as life through me difficult pitches, I'd estimate my "returns" have barely averaged around inflation--I basically have what I put in. It's potentially a mistake to just assume you'll average 8% going forward forever.

What country are you in? As of 2015 the S&P 500's average annualized return was ~8% for the past 20 years. In terms of individual years, the benchmark nearly always beats inflation handily. If you're an American and you were passively investing in index funds, I don't understand how you could only have what you started with, or anything near that amount.

Like I said, unlucky in that I had to stop investing and take money out during downturns (which typically happen at the bottom of the market). Not timing the market or "actively investing", you know--dealing with real life.

The whole "you'll average 8%" (or 5% or whatever number gets quoted) is an idealized figure assuming you always buy and hold periodically and regularly and never need to stop or withdraw to deal with life's many curveballs.

Ah, I understand now. I didn't understand your original comment when you were trying to point that out.

Since the 2000 peak, the S&P 500 has returned ~3% pa. Throw in the fact that many funds back then were charging some 2% pa, and transaction costs with some in and out, and you can easily have not much more than what you started with (particularly in real terms).

I did this analysis a while ago:


The first question is: What window are you looking at? For 30 years, it's about 6.8% for the last 30 years (inflation adjusted - close to 10% if you ignore inflation).

I've plotted it for each 30 year period going way back. 6.8% is not high. It's been well over 10% a number of times. I think 7% is a good average.

His figure was from a 10 year window. Unless you plan to retire in that timeframe, I would suggest just looking at a larger window. Less volatility.

Oh, and based on my plots, his 8% looks like it is inflation adjusted.

If memory serves me correctly, the average number you'd see used everywhere pre-2008 was more like 10%.

The problem with looking at extremely long periods of time (i.e., 50 years) is you see these massive events like depressions and the housing crisis. How many of those will happen in the next few decades... who knows?

Maybe we'd be better off to look at median percentages than averages.

Depends on how conservative you want to be. For me personally I've been using an inflation-adjusted rate of 5% annually, but I consider that very conservative and hope to realize a much longer rate over my time horizon. But if I do realize only 5% annualized, I will be sure to have more than enough to not live in squalor.

If realized rates over the next ~30 years are less than 5%, not only are we as a civilization going to have bigger problems than my retirement, but I don't think much anything will save you regardless of how much you are saving, unless you have a very frugal retirement.

Historical long term real rates hover around 6%, and I'd consider real rates of 5% for the next decade quite optimistic, not conservative.

Also, regarding safe withdrawal rates, consider that (depending on the jurisdiction) in retirement you might have to pay taxes on the nominal rates, but then leave enough to compensate for inflation.

Say: 4% nominal, pay 25% taxes, leaves you with 3%, but 2% inflation, so you can safely withdraw only 1%. Thus, conservatively, $1m might give you only 10k a year.

From 1871 to the end of 2015 returned 6.86% annualized in real dollars. Most 30-year periods you can pick out average either that or above, save a few odd periods. [1]

I use [2] to do most of my predictions. I think you are being way conservative with assuming a 4% withdrawal rate will only give you $10k real dollars on $1m invested, but everyone has different risk tolerances and assumptions :)

1. http://www.moneychimp.com/features/market_cagr.htm 2. http://www.firecalc.com/

Agreed, 1% withdrawal is (hopefully) worst case. But given the last decade, 4% strikes me as not particularly conservative.

Disclaimer: I'm looking primarily at Germany and HK, where growth and equity returns, respectively, have been lacklustre over the last decade. Though, even the S&P 500 has only made 2.5% p.a. since 2000.

> "Open a traditional IRA or a Roth IRA. The traditional IRA contributes pre-tax money, the Roth IRA post-tax money. The upshot is that if you believe your marginal rate at retirement to be higher than your present rate, you should pick a Roth IRA, otherwise, you should pick a traditional IRA. If you don’t feel like forecasting that, take my word for it that 90% of you should have Roth IRAs."

I simply cannot fathom why he would state that. I cannot imagine a scenario where my retirement income would (nor should) be as high or higher than my peak earning years.

Typically in retirement you have a home and all sorts of hard goods (clothes, furniture, cars) paid off and thus need less money.

The risk that favors Roth IRAs includes the risk that the tax code will change to include higher rates than the current tax code.

Also note that any increased or decreased "need" doesn't factor in to the calculation.

The rates would need to go up enough so that your overall tax rate in retirement is greater than the marginal rate you pay taxes at today. That would be quite the taxation increase, probably above the historical norm at any point in the US, unless you're well above the 33% bracket, in which case the probability of your rates increasing is a lot higher.

If you live in Silicon Valley, a new grad would probably be in the 28% or 33% bracket just to be able to afford renting a studio apartment on their own.

GP is talking about Federal brackets. 33% starts at $190,150 AGI (after deductions) which is well above what a new grad could expect (from their employer) or require to pay rent, even in the valley.

It's also worth noting that by historical standards tax rates are actually low. So if we assume the possibility of mean reversion they could well be higher.

I see the Roth/Regular as a bet-hedging opportunity - ideally, put some in each type and then you are ensured against either scenario.

US income taxes are at historically low levels too.

There is a difference between nominal rate and effective rate. The effective rates are fairly close to the past for high wage earners, lower for low wage earners.

>...In 1958, approximately two million filers (4.4% of all taxpayers) earned the $12,000 or more for married couples needed to face marginal rates as high as 30%. These Americans paid about 35% of all income taxes. And now? In 2010, 3.9 million taxpayers (2.75% of all taxpayers) were subjected to rates that were 33% or higher. These Americans—many of whom would hardly call themselves wealthy—reported an adjusted gross income of $209,000 or higher, and they paid 49.7% of all income taxes.

>In contrast, the share of taxes paid by the bottom two-thirds of taxpayers has fallen dramatically over the same period. In 1958, these Americans accounted for 41.3% of adjusted gross income and paid 29% of all federal taxes. By 2010, their share of adjusted gross income had fallen to 22.5%. But their share of taxes paid fell far more dramatically—to 6.7%. The 77% decline represents the single biggest difference in the way the tax burden is shared in this country since the late 1950s.


I would disagree - prior to WWI there was no income tax. Further, not every state implanted income taxes (some still don't have any)

Some states (Texas) don't have income tax but have very high property taxes to offset this. Or they have high sales tax.

undefined != 0

Seems like in the case of tax, it does. They weren't taking a random % of income in income tax based on what was in the memory cell from the previous call stack. They were taking 0%.

This is an interesting point, but not something we can solidly plan on. Vs we can absolutely say what the best way to play the game is based on todays rules.

It's a pretty safe bet that the next 30-40 years is going to explode in entitlements spending and infrastructure costs.

If the government folks don't pay them, then it's going to basically be Mad Max and your IRA (whatever the type) won't really help you much.

If the government folks do pay them, then the money for that has to come from somewhere. It's very unlikely to come from businesses, because the little ones don't make enough and the big ones pay very bright lawyers and accountants to keep the .gov away (cough Apple cough). So, it's probably going to come from income tax.

Get a Roth.

If you consider the risk of massive tax rate increases over 30-40 years significant, due to the need to pay for massive entitlement and infrastructure spending, also consider the risk that they will tax Roth capital gain withdrawls to pay for it as well.

In which case you've lost nothing since that money wouldve been in a conventional account and taxed to hell anyways.

Put it in the IRA and if things don't go to shit, your money is fine. Don't put it in the IRA and of things go to shit, lose the tax advantage.

Do either and things go to shit, it doesn't matter which you did.

No, that money would have been in a 401k, so you would lose out on the initial benefit of not having paid taxes when you contributed if they raid Roths.

But, if you've already maxed out your other tax-advantaged space, and you have more money to contribute, there is no reason not to put it in a Roth instead of a regular taxable account, assuming you are eligible, because then you can have tax-free growth at least(worth less than tax-free contributions, but still worth a lot).

In the same scenario that Roth IRAs are at risk of extra taxation (or fees), 401(k)s are as well. That doomsday scenario isn't worth planning for with money, but with physical assets (property, food, tools) and skills because that's the scenario where the US economy collapses (not a recoverable crash like 1929 or 2008, but a true, complete collapse where the USD value goes to zero).

Roth IRAs make sense if you make too much to contribute to a Traditional IRA with tax advantaged contributions and little enough to still qualify for the Roth.

They also (both traditional and roth) have an advantage over a 401(k): You get to manage the funds any way you want. You also get to contribute even when your employer doesn't have one, you just need income (capital gains don't count, as I understand it, so being semi-retired and living off your earnings does preclude you from contributing).

You're also limited on 401(k) investments to whatever your employer contracted for. Could be shitty, could be stellar, you don't control it.

That's what I try to be mindful of regarding Roth. How strong is the promise that it won't be taxed? Or maybe it isn't taxed, but new fees are introduced as a roundabout tax.

Like a lot of retirement thinking, it's unsettling to think about the negative scenarios.

I think it is unlikely, but the chance that they will tax Roth withdrawals is positively correlated with the very scenario that makes contributing to them advantageous, a massive tax hike in the future. If the government needs money that badly, everything is potentially on the table, down to a flat haircut tax on bank balances.

Income early in one's career is typically lower than incomes later in one's career. So even if retirement income is lower than final career income, there's still a good chance it's greater than entry-level income and would be taxed at a higher rate. You've also got to keep in mind that taxes may eventually rise. America's top rate today is much, much lower than the top rate historically--no reason to believe it couldn't swing back the other way.

oh i see the pattern like someone making $50k a year to start, but rises to $150k by end of career and whom is planning for a retirement income of the average (100k)... Then a Roth is a good deal when making $50k (at the beginning) and regular is better when making $150k (at the end)...


If you are making $50K/year - it does NOT make sense to save in order to push retirement income up to $100K/year.

On the other hand, saving when you have $150K/year income in order to push your retirement up to $100K/year could make sense.

(All numbers in this example are inflation adjusted to each other)

Keep in mind Roth is no longer an option after 120k.

I think it's incorrect to compare marginal rates as well. It makes more sense to compare your Effective Rate in retirement versus your Marginal Rate of today. This article explains the math: http://www.gocurrycracker.com/roth-sucks/

Your effective tax rate is likely to be much less than your marginal rate.

Also, for anyone interested in financial independence and simple investing with your 401k and IRAs, I'd like to recommend the Stock Series here: http://jlcollinsnh.com/stock-series/

This is a really good point. Now I'm pissed that I contributed to a Roth earlier in my career.

Another one that no one has mentioned: state income tax. I live in CA but would put a >50% chance that I will live in a lower tax state when I retire. Thus, Traditional > Roth.

If you are going to contribute to a Roth, it is better to do it earlier than not, while your earnings are lower, so at least you have that going for you. It can also make it easier if you ever decide to do a backdoor Roth in the future(for you know, when you have tons of money kicking around after you are contributing the max to your 401k and have your mortgage(s) paid off), since it could be hard to open a Roth account after you are over the income limit.

> I simply cannot fathom why he would state that.

Me either, unless he assumes:

    1) His audience is all tech workers, and
    2) all tech workers are making better than $62k (single earner) or
       whatever the higher married-jointly exclusion is.
That's not so unreasonable.

The only situations I can think of where Roth might make sense are 1) early stages of your career, before you hit the 28% marginal rate and 2) if you are still eligible for a Roth, but already maximized your other tax-advantaged space in 401(k)s and IRAs.

> if you are still eligible for a Roth, but already maximized your other tax-advantaged space in 401(k)s and IRAs.

Under what conditions could this occur?

If you make more than ~$62k (single earner) and have an employer 401(k) program, you're not eligible to deduct traditional IRA contributions. (Non-deductible traditional IRA contributions get a worse tax treatment than a taxable brokerage account.)

At very roughly $120k-$130k (single earner; I forget the exact figure) you're no longer eligible for Roth IRA contributions. However, you can make non-deductible Traditional IRA contributions and then do a Traditional-to-Roth conversion (not "recharacterization"). This is known as a "Backdoor Roth IRA contribution" and is legal and explained in nauseating detail on the internet.


> Under what conditions could this occur?

If you make more than ~$62k, have an employer 401(k), and contribute the maximum to it, funding a Roth IRA is a good idea.

(Unless you have an existing traditional IRA balance which would make backdoor Roth funding counter-productive due to the pro rata …. blah blah. If you don't have an existing Traditional IRA balance it's not a problem.)

When you want to do a back-door Roth IRA for one.


When you make under $132,000 but were still able to contribute $18,000 to your 401k.

One issue with the Roth is the amount you can contribute phases out with increasing income, to the point that you can't contribute if you file single and your income exceeds $132k (or $194k for joint filings).

That must be a nice problem to have. Realistically this probably doesn't hit many people, and the ones it does hit already afford accountants who conjure up ways to minimize their taxes. Yea, I know, this is HN, where everyone knows that buddy who's cousin's roommate makes $400K at Google. The average geek doesn't have to worry about this.

The Roth phaseout starts at $117k for single earners. That is a lot of money, more than most people in the US, let alone the world, make, but it is not a princely sum for most technologists, especially not ones on HN.

FWIW, Fidelity makes it very easy to make a "back door" Roth contribution, but only if you don't have a Traditional/Rollover IRA. You make a taxable contribution to a zero-balance Traditional, and then transfer it to the Roth. There aren't income limits on Roth transfers.

"Backdoor Roth."

Also neglects to mention you can have a 401k and a Roth IRA and that if you have a spouse with income they can open up a Roth as well. For financial advice I think it's really important not to miss details like that.

Also an HSA can be used to shelter a bit more income. If you don't consume much health care a HDHP may be the way to go.

There is also the backdoor Roth, but I never wrapped my head around it.

The gist of the backdoor Roth is that you make a traditional contribution and then roll it over into a Roth before tax season. There is no income limit on roll-overs and you aren't taking the benefit of a traditional IRA at tax time so the IRS doesn't care that you set it up in the first place.

Even if you can guarantee that your retirement income wouldn't be higher, you can't guarantee that your tax would be lower either. So I'd have both traditional and Roth IRA (e.g., 50/50)

A 50/50 traditional/roth allocation suggests you see it as even odds that your overall tax rate will be higher in retirement than your marginal rate today. That would require quite the rise in taxation rates, depending on exactly what your marginal rate is today. It is very easy currently to be married and make > $150k with a marginal rate of 25% and effective rate of < 15%. So, if you decided to draw exactly $150k each year in retirement, much more than you would be likely to need in any case, your effective rate would have to go up by over 10% to make it worth it to contribute to a Roth today. If you are drawing less than $150k, your effective rate on less income would have to go up 10%. This seems incredibly unlikely in our political environment, more like 80/20 or 90/10 odds.

> That would require quite the rise in taxation rates

Take a look at any of the Millenials working in any large-city downtown: they spend every single penny they earn, they have no savings; when they get older, either the State will let them starve to death, or taxes will be raised in order to take care of them.

I don't think the former is politically possible, so taxes will have to go up.

Meanwhile, the same spendthrifts are by-and-large refusing to have children early, which means that there will be fewer workers to pay those taxes.

That means that there will be tremendous political pressure to raid 401(k) plans and IRAs. I actually believe it's even odds whether Roths will end up taxed one way or another (perhaps with 'withdrawal fees' or some form of Social Security clawback or something): it'll be too much money for the State to leave alone.

While no one can predict the future, I tend to agree with your hypothesis.

The advantage of a 401K over the Roth is that since both can be raided, at least with the 401K your money is being taxed only on the way out. With the Roth you are being taxed on the way in for sure, and you run the risk of it being taxed on the way out as well.

Judging from the past my guess would be that we wont see something as obvious as a penalty or a fee. Instead what you may see is a more aggressive required minimum distribution schedule. Perhaps you could see the date of penalty free withdrawal pushed back from 59.5 to 65 or 67 years of age. Means testing of social security benefits has been mentioned before. If that gets put in place, and you fail the means test for social security, they will have effectively taxed you more your entire working life.

I agree that the risk of Roths being raided is quite high if we get to the point of taxes being raised that significantly to cause them to be valuable, so I don't really see a benefit personally of making significant contributions to one. I think raiding of 401ks is much less likely, as a lot more people have them and would be affected, and even if they do, you are still going to be better off than having contributed to a Roth unless they outright confiscate your balance, since you will have at least have avoided paying taxes in the past.

Or we could just continue doing what we are currently, and just keep piling up the debt :) No tax increase or Roth/401k raids needed.

> Take a look at any of the Millenials working in any large-city downtown: they spend every single penny they earn, they have no savings; when they get older, either the State will let them starve to death, or taxes will be raised in order to take care of them.

Don't forget the more politically expedient (and in my view most likely) choice: Print money to pay for it, causing inflation, which is essentially a silent tax on everyone with money.

You must know a different group of millennials than I do (anecdata at best).

Why should you compare using your overall rate in retirement? Is there some assumption here that most or all of your retirement income is coming from tax-advantaged accounts? That's probably the wrong calculation to make for high earners.

Depends on your definition of high earners, but most everyone that earns a living from W-2 income and is in the technology industry will be able to retire very easily by contributing as much as they can, preferably the max(currently $18,500) to their 401k and thereafter maximizing other tax-advantaged spaces such as Roth 401ks and IRAs over their working career. You would need to either be retiring exceptionally early, with less than 20 years of working life, or retire expecting to draw more than you earned in salary, to require after-tax investments to retire. Even if you do require after-tax investments, the preponderance of your income in retirement will most likely still come from those tax advantaged spaces, assuming you are a rational actor and wish to pay as little tax as possible. The only situation I can see where this doesn't apply is when you don't earn the majority of your income from W-2 wages and instead see it as long-term capital gains, in which case almost none of the advice in this entire comment thread is applicable and you should seek a fiduciary advisor.

> retiring exceptionally early, with less than 20 years of working life

This is an assumption I'm working under, but I've thought about it for a more normal case as well.

Still, the usual advice for saving for a normal retirement is 10%-15%, and you only have to break $185k before a 401(k) doesn't cover even the low end of that.

Well you have to consider matching numbers in that as well. My employer contributes 10%, which is on the high end of normal, but not that abnormal for most highly paid positions. It is easy to contribute 20%+ making over the 33% bracket and not even touch 401k total contribution limits that way(total limit is currently $53k). If you are making that much and your employer is not contributing a lot to your 401k it is definitely worth your while economically to convince them to do so(and when you are making that much you will have the clout to make them do so). Remember, the whole point of 401(k) plans initially was as a backdoor way to compensate high earners.

Also, if you're making that much, even if you want to retire early, the normal % rules of thumb don't necessarily apply, assuming you want to live a normal middle-class life in retirement. You should run the numbers on http://firecalc.com, you will find if you live frugally making that much and contribute the max you can easily retire in under 20 years with a >90% chance of success. If you want to retire to the high life you will either have to contribute more than normal(and invest well/be lucky) or work longer, no matter your income.

Edit: I will say that there is a potentially significant disadvantage, especially for high earners, in having a lot of your net worth tied up in a 401k. That is required minimum distributions, essentially forcing you to take out a certain percentage of your account balance when you reach certain age thresholds. You can somewhat easily get around this by rolling over into a Roth IRA(backdoor Roth), but that could offset many of the tax advantages of the 401k in the first place if you have significant traditional IRA holdings[1]. This is mostly deleterious if you are planning on bequeathing an estate in a tax-advantaged way, but you may be able to get around it with a irrevocable trust. Consult a fiduciary, this is not financial advice.

1. https://www.bogleheads.org/wiki/Backdoor_Roth_IRA#Caution

> and thus need less money.

Medical bills.


not mentioned is the income limits. Almost every engineer I work with is over the limit for Roth, and definitely over the limit for deductible tira. Non deductible has very little benefit, so might as well go with Roth, or back door into a Roth.

I look at it as diversifying against tax law going crazy though, siNce so much of my retirement income is in 401k and pretax. Also the limits are a third of 401k, so it's only a quarter of retirement savings, and principal can be pulled out if needed.

If you aren't contributing the max to your 401k and IRA I would do that before considering Roth contributions, unless you really believe tax rates will explode such that your overall rate in retirement is higher than your marginal rate today. If that is the case you should also consider the risk that the law will be changed to tax Roth on withdrawal of capital gains, which I believe has been floated in the past.

And the risk that the tax laws on 401k will change too. Also, I missed that's in the self employed section so I don't know much about that. But if you have and can afford to max out a 401k, you probably can't get a deductible tira so it's really a question of taxable account vs Roth.

How would 401k laws change, you are already taxed when you withdraw from a 401k normally? The risk with Roth laws changing is you get double-taxed because the government needs money, with a 401k you have gotten the benefit the moment you contribute money to it, after that all they can do is literally confiscate money from it, or change it to a regular taxable account, but you've still already come out ahead of contributing to a Roth in either case.

> How would 401k laws change, you are already taxed when you withdraw from a 401k normally?

I can imagine wealth taxes at some point ('those fat cats never paid taxes on all that money!').

Frankly, I don't think it's possible to be too pessimistic about the future.

If we end up with wealth taxes you are still more screwed by contributing to a Roth instead of a 401k, because at least with the 401k you avoided paying taxes in the past.

Depends on whether the tax is the same on Roth and Traditional accounts (Why are you comparing 401k and Roth? They are completely orthogonal concepts.). If there is a tax, deductions for past taxes paid on Roth accounts are likely.

> Why are you comparing 401k and Roth? They are completely orthogonal concepts.

Because the entire thesis of this thread is that it is better to contribute to a 401k and other pretax accounts before contributing to a Roth under nearly all circumstances(other than at the beginning of your career) that don't involve massive tax raises in the future.

Roth 401(k)s (and traditional IRAs) do exist, you know...

For taxation purposes, traditional tax-exempt IRAs are equivalent to 401(k)s, and Roth 401(k)s are equivalent to Roth IRAs. Whenever someone refers to contributing to one type of account or the other over another type of account, the ones that are equivalent are... equivalent(for taxation purposes).

Right, so the correct classification is traditional and Roth, not 401(k) and Roth.

> Non deductible has very little benefit, so might as well go with Roth, or back door into a Roth.

Non-deductible IRA actually gets a worse tax treatment than an ordinary taxable account, due to the long-term capital gains rate being lower than the income tax rate.

You can take your contributions (the principal, not the growth) out of a Roth account before you reach retirement age. The exact rules are complicated, but that's the big core benefit that has me putting money in a Roth. I can use it to retire at 40, or cash out some of it to make a down payment on a house.

You can also take your principal (and earnings) out of a traditional IRA penalty free if you work through the loopholes. http://www.madfientist.com/how-to-access-retirement-funds-ea...

This is info people should be aware of, but it doesn't help me if I only have money in a traditional IRA and want to use $100k for a down payment on a house.

Actually, I think buying a (first) house is one of the loopholes. From the linked article:

> "...you can withdraw retirement account money early to pay for education expenses, fund a first-time home purchase, ..."

Only up to $10k. I can withdraw $10k from my traditional IRA using that loophole, then a lot more from my roth.

If you decide to retire early you can always set up a Roth conversion ladder by rolling over IRAs and 401ks to Roth IRAs. It takes 5 years for those contributions to "season" so that you can take them out before 59.5, but you can take out capital gains that way as well. No need to contribute to a Roth today if that doesn't make sense otherwise.

Can you elaborate on this? I've been managing a post-tax account somewhat like a Roth IRA, though it is not an IRA because I plan to retire far before 59 1/2. I'm hoping for something in the middle of the two approaches with flexibility to withdraw early without penalty.

This is the most concise summary I've seen, but you can find some more discussion googling around for "Roth Conversion Ladder" - http://retireby40.org/roth-ira-conversion-ladder-minimize-ta...

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