One question that comes up a bunch when you are starting to save seriously is whether to save in your work’s 401k plan or through your own IRA. We’ll talk about the difference between a Roth IRA/401k and traditional IRA/401k later but for now let’s assume we’re talking about traditional retirement accounts. The arguments will probably apply to both however.
The best advantage of a 401K is that you often get matching funds from your employer. Free money is free money. If your work offers a match and you aren’t taking advantage of it you’re commuting a worse financial crime than using high interest credit cards. It’s that bad. Stop eating out, cancel cable, do whatever you have to do to get the match. (Okay, don’t stop paying your mortgage.) (Do move into a cheaper place though). Another advantage is that since businesses are large institutions sometimes they can negotiate better deals on fees. Sometimes there are worse fees though and you should make a comparison so that you know. One of the last advantages is more restrictions. Generally in a 401(K) it’s harder to get your money out because you need permission. You won’t wake up one day and decide to buy a boat emptying your retirement to do it. You may think that only other people make mistakes like that, but that’s what they thought too, until it wasn’t.
The biggest advantage of the IRA is flexibility. You can choose almost any traded investment under the sun. You can hold gold or even real estate through an IRA. This is a huge advantage over 401(K) plans. Sometimes this means that you can find a better deal on an investment product like an index fund because you have more capability to shop around. You also have some more flexibility when it comes to taking your money out. Worse case scenario you pay regular taxes + 10%. You are never at the mercy of someone else telling you that you can’t have your own money. You might also find it a minor advantage that when you leave your job you don’t have to do any paperwork.
There are some tiers here. First thing, you need to put enough in the 401k to get the maximum match. Just do it, you think you’ll miss the money but you won’t. Sell anything that somebody will pay a buck for, go back to the article on ways to make money you haven’t tried.
Now there is a corner-case where you might not want to take the match. If the 401(K) plan is really bad and charges 2% more in fees annually than the investment you could make in your IRA and you are certain you’ll be in this position for the next 32 years. Then, and only then, invest in the IRA for the first year before getting the match in the second year and so on. That’s because the additional 2% in fees you don’t have to pay compound to a doubling over ~32 years. This is such a ridiculous scenario I feel dumb even suggesting it, but it goes to show how crazy the scenario has to be for you to skip the match.
After you’ve gotten at least the match it becomes a lot closer of a decision. If you think you’re an investment expert, you should probably just go with the 401(K). You need the restrictions because if you need this question answered for you and you think you’re an expert you’ll probably lose all your money. It’s a blessing that your 401(k) has some basic guardrails. Take advantage of them. If you’re very even tempered and are willing to read a bunch of textbooks on the subject of investing you’ll probably be better off with the IRA. Keep in mind that you still need to be careful. You’re in competition with professionals and you’re turning the bumpers off.
If you’re contributing more than the limit of your preferred one just try to max out both. Tax shelters are awesome. Use them. People constantly complain about the tax shelters the rich use and the reality is that they pale in comparison to the tax shelters the middle class has access to. Plan carefully enough and someone making $40,000 per year could pay zero income tax. Use your tax sheltered space!
Step 6: Register a Business Name
This is sometimes called a DBA (stands for “doing business as”) name. This turned out to be flatly easier than I really anticipated it to be. The SBA webpage has links to different state webpages. The one for Colorado, which I’ll be using as an example is here. Click on the “File a business document” link.
Finally in order to register my sole proprietorship I need to click on the “Trade Name” link.
Here we are at yet another screen. Makes you wonder how many forms there must be to have this many layers of this many options…
Now that we’re onto the form you’ll notice that we’re going to get charged $20. A surprisingly reasonable fee in my view. To be entirely honest I thought this was going to be somewhat more expensive. The form starts out straightforward. What’s your address etc. You’ll need to know what you want your “trade name” to be. The question here is, “what is the name of your business”. Hopefully you can answer that by now. There’s an additional section I found interesting though. The “delayed effective date”. Why would I want this?
This could be useful if you were converting a sole proprietorship to some other form of entity that was taxed a little differently. By filing with a delayed effective date you can make sure that the business takes its new tax treatment exactly on the first of the year or something useful, so that you don’t have to file an extra form for one year. Additionally, sometimes States get swamped with new business filings. If you wait until you need the business created then choose for it to take effect immediately you may have to wait longer for confirmation. If you file in advance and choose the delayed effective date you can control what day it begins on because you’ll be at the front of the line.
Step 7: Get a Tax Identification Number
To apply for an EIN (employer identification number) you have to go to this webpage. You can also do it by mail, but honestly, how crazy would you have to be? (Very). Judging from this questionairre I’m actually not required to get an EIN. I think I’ll go ahead and do it anyway, maybe I’ll end up hiring a secretary or something.
Fortunately the process is pretty simple. We do need to keep track of the Doing-Business-As name that we signed up for in Step 6. All-in-all this turned out to be more intimidating than it was difficult. Looking at all this I start to wonder how hard it would actually be to hire an employee.
Reading is simply the easiest way to cram a lot of new information into your skull. I’m a little skeptical that it does quite as much good if you end up reading exactly what everyone else is reading. With that in mind here are three books I bet you haven’t read.
Early Retirement Extreme by Jacob Lund Fisker
This is a fundamental reworking of how you view personal finance. I have always summarized the argument as, if you are an environmentalist libertarian you only need to work for five years. Jacob points out the massive waste and fragility of consumer society. He points out that if you’re willing to live in a house the size of your grandparents, drive a car as often as they did, and prepare your own meals in an efficient fashion you can probably save 80% of your income. You then invest this savings as you wish over five years, after which you are financially independent and no longer need to work. The book details a philosophy and grounding theory for the whole framework. It reads like a technical manual for quickly achieving financial independence, which it basically is.
I might be cheating with this one, maybe you have heard of it. If you have or haven’t pick it up again as it’s a fast read. It was originally published in the 1920’s and details the advice of the so-called Richest Man in Babylon. It probably doesn’t have any advice you’ve haven’t already heard in some form or another. It does drive home precisely how you should think about money. An exchange early in the book goes thusly:
Then he looked at me shrewdly from under his shaggy brows and said in a low, forceful tone, “I found the road to wealth when I decided that a part of all I earned was mine to keep. And so will you.”
Then he continued to look at me with a glance that I could feel pierce me but said no more.
“Is that all?” I asked.
“That was sufficient to change the heart of a sheep herder into the heart of a money lender,” he replied.
“But all I earn is mine to keep, is it not?” I demanded.
“Far from it,” he replied. “Do you not pay the garment- maker? Do you not pay the sandalmaker? Do you not pay for the things you eat? Can you live in Babylon without spending? What have you to show for your earnings of the past mouth? What for the past year? Fool! You pay to everyone but yourself. Dullard, you labor for others. As well be a slave and work for what your master gives you 12 to eat and wear. If you did keep for yourself one-tenth of all you earn, how much would you have in ten years?”
Basically everything you need to know about the standard theory of personal finance is in this book. Everything else is execution.
Reviving the Invisible Hand By Deepak Lal
This is an economics book which details why free markets are effective and how the fall of the first liberal economic order under the British empire caused a whole host of problems. It also covers the benefits of the current second liberal economic order under the United States. The book is full of all sorts evidence about the nature of capitalism and why things like free trade are so important. It covers almost every facet of classical liberal thinking. The citations often take you to economic papers which will get you well versed in the literature if that’s your thing. It is otherwise a completely indispensable book if you are currently a socialist. Nothing is more important in finance and investing than trying to figure out what’s actually going on compared to what you wish was going on. If you don’t have at least a cursory understanding of what your opponents actually think rather than some nonsensical straw men you’re going to have a bad time. If you already view yourself as a classical liberal it is still probably worth reading because of the sheer volume of information. I thought myself well versed on the subject and I couldn’t go a chapter without learning something really useful. One example stands out, “Why is an above market return on invested capital not a sign of market failure?”
What’s the most reliable way to identify an amateur at a poker table? I’ll give you a hint, it’s not the guy making mistakes. It’s the one who gets loudly angry at him for making mistakes, when he loses in an unlikely fashion he just can’t stand to keep his mouth shut and just has to explain at length why he shouldn’t have lost and why the other guy made such a big mistake. In poker, you want your opponents to make mistakes, why would you explain what they did wrong? The reason is that the amateur’s sense of self-worth is wrapped up in winning each hand. If he* loses, to soothe his ego he has to explain why he made the “right” decision and the other person made the “wrong” decision. He* has traded his ego for future profits. I hope that I’m not showing off my amatuerishness doing precisely the same thing here.
I read this (If You Have Savings In Your 20s, Something’s Wrong) article. Please take a moment and read it, or at least the opening few paragraphs. I suppose if the author, Lauren Martin, decides to use all of her savings eating out, buying clothes and going out at night, all the better for me. The dollars she spends wind up (in a very small part) going into my pocket. In a sense this is a perfectly fair transaction. She works at a magazine which earns money in part by selling advertisements for companies I own (like t-mobile), through a broker (looks like google ad services) that I own, then spends that money at businesses that I own. I’d be willing to bet that she hasn’t gone a day without somehow giving a little bit of money. How do I achieve this feat? Well, I contribute to a 401(K) type plan (here’s what she had to say about those):
When you care about your 401k, your life is just “k”
When you’re 40, you’re not going to look back on your 20s and be grateful for the few thousand you saved. You’re going to be full of regret.
You’ll regret the experiences you didn’t take, the people you didn’t meet and the fun you didn’t have because you were too worried about a future that came and went.
I’m not quite sure what kind of world it would be if the difference between me saving 10% of my income and saving 0% of my income caused me to miss out on a lot of experiences, people, and fun. Honestly, I find that the first dollar I earn is really important to me, the second dollar is less so, but the last dollar I earn? It isn’t critical to my happiness, people may find it hard to believe, but I don’t miss my 401k savings.
Now I’m inclined to think this is all okay. I don’t need to consume everything I earn right now to be happy, evidently this girl does. We’ve found an agreeable arrangement where I provide my capital to businesses which are required to keep Lauren happy. In return I get to earn a profit on that capital. Fair deal, right?
They want us to save because it provides us with a safety net, but that’s exactly why we shouldn’t. Their need for us to have a safety net is just a giant metaphor for the difference between our parent’s generation and ours.
The only problem that I have with this is that I don’t honestly believe that Lauren has thought this all the way through. She seems to think that money represents safety. It can. If you have a nest egg you are more capable of dealing with problems as they come, but that’s not the real reason. You buy insurance for safety. If you lose your job, that’s what unemployment insurance is for. If you get sick, that’s what health insurance is for. If you become disabled, disability insurance. If you die, life insurance. These are important things to have, and you often need a little savings to supplement them. However, it is not the reason that we save.
The Real Reason to Save
Freedom is the real reason. Savings give you options. Options that folks that won’t save don’t have. A little savings gives you a few options. If you save up six months of expenses that’s six months of your life that you can do anything you want with. I had a close friend that also has the savings bug. I’ve not seen her deprive herself of the company of friends or eating out in my memory. Nevertheless she managed to save some money. Last year she quit her job to go study a language in Europe for six weeks. According to her it was an irreplaceable experience. Someone who spends every last dime doesn’t have that kind of flexibility in their lives.
What if you save more money?
Six months of expenses is enough to allow you to quit your job and not worry. You’ve got plenty of time to find another one. What if you save more though? The 4% rule is a common rule in early retirement the basic idea is that if you only spending 4% of your invested capital annually you will probably never run out of money. You could spend the same amount (adjusted for inflation) every year and more likely than not end up with more money by the day you die. That means to quit your job (permanently) you just need to save up 25 times this year’s expenses. (Granted that’s a massive amount). It also means that if you save up 6 years of expenses, you would only need to cover nine months worth of expenses out of a year. You could take a 3-month sabbatical to somewhere new every year, forever. If you save up 12 years of expenses, that’s only half the year you need to work. The profits from all the 20-somethings in the world spending their every last dime “enjoying life” really add up, don’t they?
I couldn’t enjoy my life because I was too busy worrying about my bank statement. I was too busy watching my savings instead of savoring my youth.
Lauren really hits the right sentiment here. This is a personal finance blog. We think about bank statements here, but we think about them so that we don’t have to worry about them. Savoring life is deeply important. Fortunately, it’s possible, even advisable, to do that with less money. Ultimately, I think the approach of Thoreau (28 when he went to Walden) rings truer to me than Lauren’s. He said:
I went to the woods because I wished to live deliberately, to front only the essential facts of life, and see if I could not learn what it had to teach, and not, when I came to die, discover that I had not lived.
Thoreau kept a very careful account of all the money he spent over the two years at Walden pond, it works out to roughly $870 in today’s dollars, I guess he didn’t need to spend money to enjoy life. My suspicion is that he had the more memorable time.
* Yes, I know I’m using the male pronoun here. There is a simple reason. I’ve never once in my life seen a female poker player behave this stupidly. Perhaps I’m being sexist. If someone can provide me an example of one woman they’ve ever seen do this I’d be happy to edit into the he/she construction.
I don’t know about you but every time I get the thought that I should be trying to make extra income I go to google (the best website) to solve my problem. Inevitably suggestions always seem to be the same thing, “sell your stuff on craigslist/ebay/garage sale”, “Tutor some folks for some extra cash”, “Use bank sign-up bonuses”. Here are four idea’s that I’m pretty sure you haven’t tried. Now many of these require some actual effort on your part. For that reason I expect about no more than 10% of you to actually make any money from this article. But the rest of you can dream about what it would be like if you were willing to make an effort, right?
- Buy a candy/gumball machine.
- The machines sell for the low 100’s of dollars. You can buy the gumballs for about $35 per 850 (same site dudes). If you sell each one for $0.25 that means that you earn about $200 on that 850 gumball unit. Your profit margin is over 80%.
- Here are the other bits that matter: what is your time to refill and repair the machine worth? Figure each refill takes an hour charging $50 per hour (including drive time etc). Figure another hour every other refill spent performing maintenance. This works out to subtracting $75 off of our refill revenue of $200. This leaves us with a gross profit of $90 per refill. Assuming that each machine will last 5 years (depreciation of $27 per year), our question becomes can you do at least $40 of profit per year. In other words can you sell all your gumballs once every 2.25 years? Generally the answer is that you can do far better than that.
- The Hard Part: You need locations. I assume that you aren’t selling these out of your home. You need to convince some place with a waiting room to let you set up a gumball machine. You can’t pay anything remotely resembling a reasonable fee. It’s not like you can offer them $20 a month for the space. That’d eat your profits alive. One suggestion I’ve heard is to tell them that you donate a portion of your revenue to charity. Say 10%? Your margins are great, so you can definitely afford this. You’re going to get shot down a bunch of times. Such is life.
- Offer to do long distance deliveries.
- Some businesses are occasionally would like to make a substantial delivery somewhere quite distant. Maybe they’re new, maybe they offer catering services of some sort. The value you can offer here is pretty substantial. Just make sure you charge enough (at least 60 cents per mile, more in the city).
- The Hard Part: Again you need to talk to actual human beings. Ideally you print up some business cards and offer the service to them before they actually need it. Do this for enough businesses and just wait for one of them to get in a bind. It’s best to look at newer businesses/restaurants and ones that sell a unique food or product. This is never going to work out if you hand your card over to the dominoes guy.
- Buy Half-Dollars
- I’m probably cheating with this one. You’ve probably heard about doing it, but its such a neat thing I can’t help but mention it.
- Ask the bank teller if they have any Roosevelt half-dollars. Later, at home, you go through them. You are looking for coins dated before 1970 (and ones marked 1976 S!). These have silver content, and they are worth ~$3-6. So you get $100 worth of them and you might get a couple, netting you 2-4% on your money.
- The Hard Part: The amount of money from this is tiny even though the return is good. This all comes down to how quickly you can check 200 half-dollars. If it takes you more than ten minutes, this is a bust. As far as banks go, I’d check in on ones while you’re on vacation.
- Vehicular Arbitrage
- This I’ve never tried but I’d be interested to hear the experience of folks. Buy a truck at an oilfield auction. It may be that oil-fields are pushing their fleet a little harder than usual with oil prices being down, so this may not be quite as common anymore. Keep in mind you are essentially buying a seat and a heater, these are no-frills trucks.
- Drive this truck to a State where trucks are more expensive, California comes to mind, but you may find something better nearby.
- The Hard Part: I have no clue. There are a lot of moving parts here. Get to an auction. Verify that prices are lower at auction than where you plan on selling it. Account for sales tax. Account for all of the little registration fee’s etc that are going to eat into your profit. The bonus here is that you get a subsidized road trip. I bet you’ve got to double your money on this before costs for it to be worth it.
These things all sound like a big pain in the neck, but they seem like they might lead to a fun story too. I don’t know, maybe you should just eBay all the crap you bought yesteryear like every other blog tells you to. It’s certainly easier, and you don’t have to have a conversation that gets you rejected. (Though I’ve always found the fees and shipping on eBay to make my life a little difficult, but your mileage may vary, and it’s got to be less of a pain that digging through quarters.)
Who’s going to win the 2016 election? There are a number of ways to figure this out. Some people look at polling data. Other people build models based on theories they have about how elections work. Some folks might argue that its nearly unpredictable, because elections should be nail bitingly close. In my favorite article on the subject Mickey Kaus argues that elections should split nearly 50-50 going for as long as we have a two party system. The basic argument here is that each party wants to win elections and stay true to its philosophy. Therefore, each party moderates their platform just enough to convince exactly the necessary number of people to vote for them. This is referred to as median voter theorem. In my view, none of these are the best way to determine who will win the election.
The Prediction Market
People are biased. They also let their biases influence their view of reality, especially if this view has no consequences. A twitter analysis showed that pundits are correct 47% of the time. People somehow become remarkably less biased when they are responsible for their predictions. Rather than looking at polls maybe you want to see what a bunch of people who actually have something to lose thought would happen. Enter the prediction market, in this case PredictIt.org. In a prediction market people buy and sell basically bets on how a particular political event will turn out. This has an advantage over regular sports-betting or political-betting in that odds aren’t set by a single experienced person. Instead odds are determined by the market. PredictIt makes this simple and pays out $1 to each holder of a correct bet. Therefore, all bets trade at fractions of a dollar. These fractions correspond to the percentage chance of the bet coming true. If Hillary Clinton has a 50% of winning the presidency, then a rational person would be willing to pay no more than 50 cents for the right to receive $1 if she wins.
On your first pass you would think that it appears that Hillary Clinton is most likely to win both the Democratic nomination (63% chance) and the presidency (42% chance). The person with the second best chance to win the presidency is Jeb Bush with 26%. (Add those together and ponder that depressing fact.) Particularly astute observers will note that there’s something funky going on here. If you add up the chance of each candidate winning you end up with more than 100%. Shouldn’t this be impossible? Shouldn’t astute traders bet no against everyone in order to collect a risk-free profit?
The answer is that an arbitrageur needs to get paid for their time and risk. If they make a bet today they still have to wait until November 2016 in order for the bet to pay off. If you assume that they need to get paid 10% on their money for their time these numbers start to make a great deal more sense. Take the “Buy No” chance and multiply it by 10% to get the opportunity cost of holding the contract. Then subtract this number from the “Latest” value. Suddenly all of the values sum to nearly 100% as expected. After making this adjustment, we realize that the standings are:
- Hillary Clinton (36.4% chance)
- Jeb Bush (18.5% chance)
- Bernie Sanders (10.9% chance)
- Donald Trump (8.4% chance)
- Marco Rubio (7.4% chance)
- Joe Biden (4.3% chance)
- John Kasich (3.1% chance)*
- Ben Carson (3.0% chance)
- Carly Fiorina (2.9% chance)
- Scott Walker (0.7% chance)
- Remaining ~7 billion people (4.6% chance)
As always, a number is useless without a +/- uncertainty attached to it. In this case the uncertainty may be estimated as the spread between the buy and sell for each bet. For example, you can buy Hillary Clinton to win at 47 cents, but only sell it for 44 cents. This implies an uncertainty of 3%. (So, in honesty I have too many digits of accuracy on these guys).
Just a few comments, first I’m firmly convinced that this is the “best guess”. These are folks who have real money on the line. Fortunately if you disagree, suppose you’re Nate Silver and you think Donald Trump has a substantially lower chance, you have every opportunity to put your money where your mouth is. (Good luck with that!**) Second, its a little relaxing to see that there’s a 80.7% chance that someone not-crazy will get elected. I sleep a little sounder knowing that.
*You may notice that I removed Chris Christie. While the last trade for him took place at 12 cents the current bidding is between 8 and 4 cents per share. The new bid-ask represents the most up to date information in illiquid markets.
**Disclaimer: You’ll probably lose all your money if you even think about this. Yup, there it went.