Should You Follow Senator Elizabeth Warren’s Investment Advice?

March 23, 2017

Last week, I wrote about some of her money management tips as described in an article titled “You, Too, Can Invest Like Elizabeth Warren!” Overall, I found them a bit too simplistic. Now let’s take a look at the investing side:

1. Visualize. Specifically, “take a moment to savor your dream.” It’s hard to argue with this. If visualizing your retirement or other goals helps motivate you to save and invest, go for it. Just remember that the dream probably won’t become reality unless you wake up and take action, which brings us to…

2. Create a retirement fund. Warren suggests contributing 10% of your income to a 401(k) or IRA. This isn’t a bad idea on its face but lacks detail. Why just 10%? The consensus seems to be that the average American household needs to save about 15% of their income for retirement so 10% is probably too low.

Even better, you should run a retirement calculator to get a more personalized number. That’s because the percentage you should be saving depends on your age, your current retirement savings, how aggressively you invest, when you want to retire, how much retirement income you need, and how much you can expect to get from Social Security and other income sources. In other words, you may need to save a lot more or a lot less, depending on your particular goals and situation.

It also matters whether you choose a 401(k) or an IRA. While they can have similar tax benefits, you’ll want to contribute at least enough to your 401(k) to get your employer’s full match. After that, your choice depends on a variety of factors like the investment options in each account and whether you prefer the convenience and simplicity of having everything in your 401(k) or the freedom and flexibility of an IRA. Don’t forget that you can also do both.

3. Invest prudently in the stock market. Warren also recommends investing another 5% (or 10% if you’ve paid off your mortgage) in an indexed mutual fund. Her own non-retirement account portfolio is largely invested in fixed and variable annuities with some money in stock, real estate, and bond funds.

Again, why 5%? The amount you save should depend on how much you’re willing to put away to reach your goals. If your goal is retirement, you’ll probably want to max out your 401(k) and IRA before investing in a taxable account. If your goal is education funding, consider tax-advantaged education accounts like a Coverdell account or 529 plan.

The index fund recommendation makes sense since compared to actively managed funds, they generally have lower costs, outperform over the long run, and generate less in taxes since they don’t trade as much. However, Warren seems to be using deferred annuities instead to shield her personal money from taxes. There are a couple of downsides to this strategy. One is that variable annuities tend to have high fees. Another is that the earnings are withdrawn first and are taxed at ordinary income tax rates.

In addition, her heirs will also have to pay taxes on the earnings they inherit after she passes away. In contrast, long term (over one year) capital gains on stocks and funds are taxed at lower tax rates and won’t be taxed at all when passed on to heirs. Her real estate and bond funds also generate a lot of taxes.

A better strategy for Warren would be to prioritize the bonds and real estate investments in her 401(k) and IRA and use the taxable accounts for the remaining stock funds. This is because stocks are more tax-efficient and their higher volatility would allow her to use losses to offset other taxes. By sticking to index funds, she could save even more in taxes and other costs.

4. Oh, and avoid investing in these: gold, prepaid funerals, and collectibles. I’m not sure I’d call prepaid funerals an investment at all, but collectibles can be a fun way for someone to speculate as long as they’re not counting on them for anything. A small amount in gold is used by many investors as a hedge against rising inflation and other types of instability and can help diversify a portfolio since it typically moves differently than stocks and bonds.

As with her money management advice, you could do a lot worse than funding a retirement account, investing in an index fund, and avoiding speculative investments. But Warren’s investment advice is a bit too oversimplified as well. Instead, find out what retirement and investing strategy makes the most sense for your particular needs or work with an unbiased financial planner who can help you. After all, we don’t all have a senator’s pension to bail us out of any mistakes.

 

Should You Follow Elizabeth Warren’s Money Management Advice?

March 16, 2017

While much of the country is discussing the president’s tax return, I stumbled upon an interesting article from a few years ago about the finances of one of the president’s possible opponents in 2020, Senator Elizabeth Warren. The article is titled “You, Too, Can Invest Like Elizabeth Warren” and is based on the information she submitted in a financial disclosure report along with tips from a financial planning book she wrote called All Your Worth: The Ultimate Lifetime Money Plan. Regardless of what you think of her politics, should you follow her financial recommendations? Before we get into the investing side next week, let’s take a look at the first set of recommendations called ”First Things First:”

1. Get debt free. Warren recommends that you “Drain your savings account, empty your checking account, and sell any stocks or bonds” to pay off all your debt. Warren herself has no debt except for a $15k student loan at 0% interest. In some ways, her advice makes a lot of sense. If you’re paying 18% interest on a credit card, paying it down is like earning a guaranteed tax-free 18% on your money and will also improve your credit score.

However, there are a couple of reasons why you might not want to “drain your savings account” to become debt-free. What if you suddenly find yourself in between jobs? You generally can’t put those mortgage or car payments on a credit card so now you risk losing your car and home. You can’t always rely on lines of credit either since they can be cancelled, especially if you’re unemployed or if the economy is weak. That’s why it’s always important to have some emergency savings (ideally enough cash to cover at least 3-6 months worth of necessary expenses) even before paying down high-interest debt.

Second, you might not want to pay off any debt balances early that have interest rates below 4-6% like many mortgages and student loans. That’s because you’re likely to earn more by investing that money instead. Perhaps that’s why Warren hasn’t paid off that  0% loan yet. This is especially true if you’re not contributing enough to your employer’s retirement plan to get the full match and leaving that free money on the table.

2. Don’t buy a sailboat if you work at Wendy’s (or are a journalist). What Warren really means is that 50% of your income should go to needs, 30% to wants, and 20% to savings. But how can you really separate “needs” and “wants?” Is your home a “need” because you “need” somewhere to live or a “want” because you’re paying extra for a really nice place you “want” in a great location? The same goes for everything from the car you drive to the food you eat.

This also seems like too much of a one-size fits all approach to me. Your spending and saving should be based on how you decide to balance your various personal goals and priorities. For example, I personally save a lot more than 20% of my income because achieving financial independence is a high priority of mine and I’m willing to live in a small studio apartment and not have a car to do it. If you work at Wendy’s and are willing to live with your parents and not spend much money so you can achieve your dream of buying a sailboat, go for it. As long as you understand and are willing to accept the trade-offs, do what makes YOU happy.

3. Pay off your mortgage if you have one. Mortgages tend to be low-interest and we already addressed the downside of paying off low-interest debt early, but mortgages have an additional benefit in that the interest is also tax-deductible. That means if you’re in the 25% tax bracket, a 4% mortgage costs you only 3% after-taxes so that’s the number you should consider when deciding whether to make extra payments. (You can calculate your mortgage tax savings here.) In fact, considering the low mortgage rates and the tax breaks, there’s even an argument for NEVER paying your mortgage off.

Of course, there’s much worse things you can do than getting debt-free, creating a money management plan, and paying off your mortgage. I just think her advice is overly simplistic. Next week, we’ll take a look at Warren’s investment advice…