Even though I am not an investment advisor and never hold
myself out as one, clients continue to ask me what to do to
prepare for retirement. Should I max out my 401(k)
contribution? Should I do an IRA? Should I put more in my
profit sharing plan or pension plan?
Contrary to popular belief, none of these are wise
investments. Why? Among other reasons, they all involve
putting money into an investment vehicle over which they
have little control as to investment and timing and most
people end up choosing Mutual Funds as their investment
within these plans. In fact, putting your money into the
Lottery would be a better investment.
Really? The Lottery as an investment vehicle? Sound crazy?
Gamble my retirement funds away in a government-sponsored
game of chance where I have little chance of winning? Where
millions of other people are putting in money in hopes of
winning the big one? Where most of the money goes to
someone else and the chances are strong that I will lose
part or all of my money?
Wait a minute - are we talking now about the Lottery or
about Mutual Funds? Hmm, a government sponsored program
where I have little chance of winning. Sounds like a lot
like Mutual Fund investment in a 401(k) or IRA. After all,
what are my chances of retiring on Mutual Fund investments?
Not very high, actually.
A couple of years ago, I was listening to a financial
program on the radio on my way into work. The interviewer
was asking the representative of a large Mutual Fund about
the performance of the Fund. The Rep responded that the
Mutual Fund had risen in value by an average of 20% per
year for the prior two years. But when the interviewer
asked about the average return to the average investor in
the Fund, the Rep responded that the average investor had
actually lost 2% per year. Why? Because of the timing of
going in and out of the market. Compare this to the
Lottery, where everyone knows the exact chances of winning
and the exact amount that could be won!
But what about the great tax advantages of putting my money
into a 401(k) or an IRA? Yeah, right! Get a tax deduction
when you are young and in a relatively low tax bracket so
you can pay taxes on the money you take out when you are
retired and in a higher tax bracket? Yeah, that's a good
deal. Or, consider the difference in tax rates on capital
gains and dividends if you are not in a 401(k) or IRA
versus the ordinary income tax rates on the earnings when
you pull them out of your 401(k) or IRA.
So now you are thinking that you should just invest in
Mutual Funds outside your 401(k) or IRA? Wrong again.
Mutual Funds result in capital gains taxes when the Fund
Managers trade them even though you don't see the money!
You have to pay taxes even though the Fund may actually
have gone down in value! And what about the lost
opportunity cost of that money that you are now paying in
taxes that you could have put into other investments? At
least with the Lottery, you know the exact amount of taxes
you can expect to pay if you win and you only have to pay
taxes if you do win.
Yes, you say, but the Lottery is gambling and I have no
control over whether I win or lose. You are right. The
Lottery is gambling. But so is a Mutual Fund. You have no
control over the stock market and neither does the Fund
Manager. The market goes down, so does your Fund. At least
you recognize that you are gambling when you play the
Lottery. You don't have the government, financial
institutions and your employer telling you that the Lottery
is a good investment. And your employer doesn't go so far
as to match the amount you put into the Lottery like it
might with your 401(k). Nobody is lying to you about the
Lottery being gambling, but those in positions of authority
are lying to you about the chances of success in a Mutual
Fund!
But surely, you say, there is a better chance of making
money in a Mutual Fund than there is in the Lottery?
Hardly. There may be less of a chance of losing all of the
money you put into a Mutual Fund than there is losing all
of the money you put into the Lottery. But you are never
going to win big in a Mutual Fund. In fact, Mutual Funds
are designed to minimize your returns by creating a
"balanced portfolio." If they could minimize your risk of
the market itself, this might be okay. But the problem is
that nobody can minimize the risk of the market without
sophisticated hedge strategies that are not typically used
in Mutual Funds. At least with the Lottery, you have a
chance of winning big. And you can sleep at night, because
you aren't wondering if the chances of winning are going
down overnight because of something that happens in Tokyo.
You say you don't like the idea that most of your Lottery
gamblings are going to support government programs? Where
do you think most of the earnings from your Mutual Fund are
going? No, not to support government programs, but rather
to support your investment advisor's and the Mutual Fund
manager's retirement? You take all of the risk, you put in
all of the capital, but most of the earnings from the
Mutual Fund go to the Fund manager and your investment
advisor. At least with the Lottery, the funds are going to
worthy causes, such as the Arts.
Of course, I would never advise a client to rely on the
Lottery for their retirement. But neither would I advise
them to rely on Mutual Fund investments. For my dollar, the
Lottery is a lot more fun and at least I know I'm gambling.
But if you want to retire, look at other investments and
work with someone who is willing to put in the time to help
you retire soon and retire rich. Financial freedom is
available to those who are willing to work and learn about
it, but not likely for those who want to rely on such risky
investment strategies as Mutual Funds.
Warmest Regards,
Tom
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http://www.tomwheelwright.com
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