Survivorship bias everywhere

Survivorship bias is one of those rare ideas that is at once instantly accessible and incredibly powerful. The classic explanation of survivorship bias is when a mutual fund company advertises the 5-year or 10-year returns of the funds it offers, without reporting the 5-year or 10-year returns of all the funds that didn't survive 5 or 10 years, since they were closed for underperformance in their first year or two. That leaves potential customers with an inflated idea of the fund company's management expertise, since the company's performance is inflated by survivorship bias.Once you understand survivorship bias, I think it's worth taking seriously and applying to a whole range of situations. The key question survivorship bias raises is: are the survivors winning for a manifestly objective reason, or are they winning because the losers have been excluded from the comparison? And how can we tell the difference?

Why does the United States have the largest economy in the world?

Once you know that the United States has the largest economy in the world, there are a lot of reasons that spring to mind to explain that achievement:

• geographic isolation means that even catastrophic global conflicts affect the United States only indirectly;
• a strong tradition of rule of law means that people are more willing to enter into long-term, speculative investments, knowing that they'll have recourse to a neutral arbiter in case of disputes over the terms of the investment;
• the protestant ethic means that Americans are unusually inclined to labor, raising the return to capital and increasing capital investment in the United States compared to other countries;
• an oppressive welfare state focused on the "working" poor over the "undeserving" poor increases the labor force participation of Americans who would otherwise perform household labor like child-rearing and elder care that would not show up in GDP calculations.

And of course all these explanations, plus as many others as you can conceive, are correct. But they're only correct once you know that America is the largest economy in the world, just as you can only calculate the 10-year annualized return of mutual funds that are still in business after 10 years.What if the United States were a country imploding with inflation and struggling to avoid default? Well, our economists would soberly conclude that:

• geographic isolation means that our natural resources and manufactures are too expensive to export to the rest of the world;
• our rule-bound judiciary isn't flexible enough to adapt to changing conditions on the ground;
• the protestant ethic means workers are willing to continue working for low wages even when they'd be better off changing jobs, returning to school, or migrating to a higher-wage country in order to improve their financial situation and remit payments home;
• a welfare state that exclusively rewards paid work has inflated the number of jobs in the unproductive childcare and eldercare sectors, while forcing workers into unproductive jobs in order to trigger the welfare payments they need to survive and care for their families.

Why do so many bloggers rely on credit card affiliate revenue?

Once you know that bloggers in the financial independence, travel hacking, and other blogging spaces rely on credit card affiliate revenue, one conclusion you could come to is that in order to maintain a successful blog, you need to rely on betraying your readers and selling them credit cards they neither want nor need, in anticipation of banks being able to earn more from the people you refer than the amount of your referral commission.But this, too, is a case of survivorship bias. It confuses the fact that a majority of surviving blogs rely on credit card affiliate revenue for the claim that in order to survive you need credit card affiliate revenue, just as people confuse the fact that the largest economy in the world has a strong tradition of rule of law for the claim that a strong tradition of rule of law is essential for having a large and growing economy (an obviously false claim, see, e.g., China, People's Republic Of).

Acknowledging survivorship bias means rethinking a whole range of conclusions

In a world subject to survivorship bias, it's never enough to look at the current state of the world and draw conclusions about how that world "really" works, because your conclusions are invariably based on the characteristics present in the successful people and institutions that survived, whether or not those same characteristics were present in the people and institutions that did not.If you're a successful professional, you're bound to attribute your success to particular characteristics you identify in yourself. But that's a sampling error, pure and simple; you don't know how many people with those identical characteristics failed to achieve your level of success.Likewise suggesting the poor, the hungry, the homeless, or the sick made the wrong decisions in their life suggests an aggressive ignorance of all the people with the same attributes, and who who made the same decisions, but who faced none of the same consequences.

Conclusion

Why is Bitcoin the most valuable cryptocurrency in the world? Is it because it's the most liquid? Is it because it has the best underlying code? Is it because it has the most distributed infrastructure? Maybe.Alternatively, since Bitcoin is the most valuable cryptocurrency in the world, people are desperate to find an explanation why, and arrive at conclusions like liquidity, code quality, and infrastructure distribution.And that is survivorship bias, pure and simple.

The effect of estate tax repeal on the 529 scam

One of the first posts I wrote here was about the 529 scam. I explained that 529 plans are a way for wealthy individuals to permanently shield an almost unlimited amount of assets from taxation, and that the scam was made sustainable by the very large number of middle class people saving a very small amount of money who are absolutely convinced that 529 plans are a way to save money for college, rather than a way for the wealthy to shield their assets from taxation.Like the mortgage interest, the state and local tax, and charitable contribution deductions, the actual benefits of 529 plans accrue to a tiny population of wealthy heirs and heiresses, who are protected from blowback by a large population of earnest upper-middle-class professionals.

What are the benefits of 529 college savings plans?

There is so much nonsense out there about 529 college savings plans that it's important to understand what the actual benefits of the plans are. There are only three:

• Internal tax-free compounding. Dividends and capital gains from the underlying investments are untaxed as long as they remain in the account, while they would be taxed if held in a taxable brokerage account.
• Tax-free withdrawals. Under certain conditions, withdrawals from the accounts are tax-free, while they would be taxable if the securities were instead held in a taxable brokerage account.
• Transfer of ownership of a 529 account is not a taxable event at the death of the account's owner, while it might be if the owner of a taxable brokerage account dies (although in that case the heir would benefit from the stepped up basis rule).

What are the limits on 529 college savings plans?

It is commonly believed that there is a limit of $14,000 in annual contributions to 529 college savings plans, or $70,000 if contributions are made upfront and reported over a 5-year period. This is precisely false.$14,000 ($70,000) is the annual (quinquennial) amount you can contribute without filing a "Gift (and Generation-Skipping Transfer) Tax Return."The actual limit on the amount you can contribute to a 529 college savings plan is the plan's maximum contribution balance. For my preferred 529 plan, the Utah Educational Savings Plan, the maximum contribution is $430,000. You can't contribute any more to the plan as long as your balance is at least that amount, but in case of a decline in the value of the account, you can "top up" the account to $430,000 again. As UESP helpfully explains:

"UESP will accept contributions for a beneficiary until all UESP account balances for that beneficiary reach $430,000. It is possible that balances may exceed $430,000 because of market performance. Contributions or portions of contributions that exceed this maximum will be returned to the contributor."

How would repeal of the estate tax affect the 529 scam?

In the absence of the estate tax, there would be no reason for our beloved oligarchs not to contribute the maximum account value to every 529 plan in the country. Without an estate tax, there would be no estate tax exclusion that such contributions could count against, and there would be no return that would need to be filed to record such transactions.To use UESP as an example again, in the absence of the estate tax, at birth every wealthy child in the country could receive a $430,000 transfer, invested in the stock market, that would compound tax-free forever, and with tax-free withdrawals when spent on eligible expenses.

About those eligible expenses

Here readers think they have caught me in some kind of trap. "A-ha," you say, "what good is an enormous tax-free inheritance that can only be spent on certain eligible expenses?"Don't worry, Ted Cruz is on the case. Senator Cruz included in the Senate version of the Republican tax reform bill a provision allowing $130,000 to be withdrawn for K-12 private school expenses, in addition to the undergraduate and graduate school withdrawals that were already allowed tax-free.Even if you're a responsible middle class professional, think about the logic of this provision. A diligent middle class saver starts investing money at the birth of their child and starts withdrawing it a few years later for private kindergarten expenses, so it's had perhaps 2 or 3 years of tax-free internal compounding. A wealthy person inherits a multi-million dollar 529 plan and is able to withdraw $10,000 per year for 13 years that has never been and will never be taxed. Then they can withdraw an unlimited additional amount, also tax-free, up to the total cost of attendance at their kid's private college and graduate school.Finally, as I mentioned in my original post, it's important to understand that a huge portion of the intergenerational transfer of wealth is precisely the transfer of educational opportunities and credentials. Far from being a "restricted" or "limited" form of inheritance, "forcing" your heirs to use a portion of their inheritance on the best private schools is far from a drawback of the 529 plan scam. For many of our oligarchs, it's the whole point.

The real reason arbitrage opportunities last so long

Every once in a while you come across a seemingly insignificant coincidence that gives a different perspective on a question you thought you understood the answer to.I had one of those moments the other day when, for the second time in the course of a few weeks, a popular economics Twitter account dismissed my suggestion that he open a high-interest checking by saying "That is a ton of small print" (it looks like the first thread was deleted but you can find it cached here for now).This made me reconsider the question: why do arbitrage opportunities last so long?

I thought arbitrage opportunities lasted because people were lazy

When you tell someone they can put their savings into a checking account that earns 50 or 100 times as much interest as their existing savings account, as long as they're willing to execute a few debit card transactions on the first day of every calendar month, it has always seemed to me the logical response should be "oh thank God!" or "how did I not know about this?" That's certainly the reaction I had when I learned about high-interest checking accounts.When people did not have that reaction, I thought I knew why. They might be lazy, and not be willing to meet the high-interest requirements. They might know themselves well enough to know that they would let the requirements slip through the cracks. Or they might simply not understand how compound interest works and what the advantages of high-interest accounts are over low-interest accounts.These can all be basically filed under the categories of laziness and ignorance.

Smart, energetic people's reaction to arbitrage opportunities is suspicion

The reaction of these two prominent Twitter personalities gave me a different perspective. Their reaction was not "I can't be bothered," or "that sounds like too much work," or "higher interest rates aren't worthwhile." Indeed, I was responding specifically to their individual complaints that they were earning too little interest on their savings.Instead, their reaction was suspicion. "That is a ton of small print." "You realize this is just a dang cash back credit card arrangement right."Instead of being upset for having missed out on higher interest rates on their savings for so long, they didn't believe it was possible they had missed out on higher interest rates for so long.There had to be a catch. But there is no catch. Arbitrage opportunities really are everywhere.

People need to get a grip on how late capitalism works

Many people, particularly those unfortunate enough to be educated in economics, still believe that late capitalist economies function by distributing global savings through capital markets to the investments which will produce the most economic output when the requisite amount of labor is applied to them. This is the "money market" described in Walter Bagehot's brilliant book "Lombard Street," in which the profitable agricultural estates of southern England send their excess cash to London for the bill brokers to lend out to the new manufacturing firms in the North.Late capitalism is not like that. Under late capitalism, the United States Mint (and Canadian Mint!) accepted credit card payments for the sale of dollar coins at face value. Under late capitalism, online mattress companies will let you try a mattress for 100 nights and then refund your money while shipping the mattress to a landfill. Under late capitalism, Uber has perfected the flow of money from venture capitalists to consumers and car-owners.In other words, arbitrage opportunities are everywhere.

If you're going to be suspicious, be suspicious of the right things

That's not to say that everything is free and easy under late capitalism. On the contrary, late capitalism goes hand in hand with what I call the "scam economy:" deals which sounds too good to be true because they are.A reader turned me on to the idea of paying folks to use my Uber referral link; it worked ok, but I barely broke even after going back and forth with the South Asian scammer I used on Fiverr.On the other hand sites like Prosper, Lending Club, Wunder Capital, and the now-ubiquitous non-traded REIT companies offer abnormally high returns, but they do so because people are rightfully suspicious about their ability to meet their debt service obligations. The higher returns they offer are compensation for higher risk, rather than arbitrage opportunities.That means before pursuing an arbitrage opportunity it's absolutely right and proper to establish what kind of protection you have, how well-established or profitable a company is, whether the company is based in the United States or elsewhere, and so on.But if a FDIC- or FCUA-insured bank or credit union is offering unusually high interest rates for meeting a couple of simple requirements each month, the logical reaction is to read the fine print, fill out the online application, and move your cash savings there — or else please stop complaining about the low interest rate on your savings account.

What is a 30-year fixed-rate mortgage?

The title of this post may sound like a rhetorical question, but I assure you I don't mean it that way. It's a question I've been pondering for a while as I come across weird datapoints from the history of home financing around the world. A 30-year fixed-rate mortgage is maybe best defined by what it is not: it's not a one-year floating-rate mortgage.

What would a one-year floating-rate mortgage look like?

There's no mechanical reason a one-year floating-rate mortgage couldn't exist. At the beginning of the first year, a home-buyer would take out a loan for the purchase price of a house, secured by the house as collateral. They'd make payments throughout the year at whatever the prevailing interest rate was (the borrower and lender could agree on whether payments would fluctuate or whether payments would be fixed and the amount of interest and principal paid would fluctuate), and then at the end of the first year, the home-buyer could either repay the remaining principal or take out another one-year floating rate mortgage to repay the balance of the original one.While there's no mechanical reason such a system couldn't exist, it has some obvious drawbacks:

• Vulnerability to changes in house value. In a rising housing market, such a system would be the equivalent of annual cash-out refinancing. In a falling housing market, it would be an annual cash call, since the borrower would have to pay the previous year's lender the amount borrowed, even if the next year's lender was unwilling to lend the full amount given the lower value of the house in year 2.
• Uncertain total repayment term or uncertain payments. In a period of rising interest rates, each year the borrower would repay less and less of their loan's principal (or face rising monthly payments). That means it might take many more than 30 years to fully own a home, even if at the beginning of each year you intend to pay off one thirtieth of your remaining principal. Uncertain monthly payments also would make it difficult to plan your expenses in advance.
• Borrower credit risk. Even if economy-wide interest rates remained steady, the interest rate an individual borrower might be forced to pay could vary from year to year as their personal credit profile changes. A higher income might lower their monthly payment in one year, while a lost job might make it impossible to roll over their loan at all — even if they have the next year's worth of payments saved up in cash!
• Lender risk. In case of an economy-wide shock to the credit market, it might not be possible to refinance a loan at all, even for the most credit-worthy borrowers. Mass foreclosures and evictions based on banking sector malfeasance would be a constant risk in an economy of one-year mortgages.
• Huge transaction costs. Presumably such a system would create streamlined refinancing offers (perhaps even interest rate discounts after a certain number of years) but verifying the credit and income of a borrower and the value of a home each year would still require an enormous amount of work, and create enormous scope for human error.

That said, there are some obvious advantages as well, for both borrowers and lenders:

• Lower interest rates. If lenders didn't have to squint at the horizon and forecast the future trajectory of interest rates, they would be able to offer much lower interest rates today. You can see this in the interest rate differential between 30-year and 15-year fixed-rates mortgages. It would be reasonable to expect the rate to be even lower for one-year floating-rate mortgages.
• Less prepayment risk. When a lender makes a mortgage loan today, they're forced to take into account the risk that if interest rates fall their customers are likely to repay their loans early and refinance into a lower-rate mortgage. That creates an unpredictable, one-way risk for the lender and for the buyers of mortgage securities. Rolling one-year loans would drastically reduce that risk, since few people would be willing to go through the hassle of refinancing a loan mid-year.
• Reduce borrower debt. Since each year borrowers would only borrow the amount they needed to repay the balance of the previous year's loan, they could use annual savings to reduce the amount borrowed each year. This is the same logical process as accelerating payments on a 30-year mortgage, but the annual refinancing process might provide a sense of immediacy or urgency to the process, or simply given borrowers a chance to look at their household assets and expenses.
• Increase home equity. Lenders would presumably insist on large down payments in order to shield themselves from the risk of a decline in the house's value between the time they make a loan and the time the borrower seeks another. Much higher home equity might contribute to fewer foreclosures and evictions in general.

A 30-year fixed-rate mortgage is a one-year floating-rate mortgage with a bunch of riders

That brings me back to the question, what is a 30-year fixed-rate mortgage? In the same way that a delayed variable annuity is an immediate fixed annuity with a bunch of riders on the contract, I think of 30-year fixed-rate mortgages as one-year floating-rate mortgages with a bunch of riders:

• instead of a floating interest rate, a fixed interest rate;
• instead of variable payments, fixed payments;
• instead of annual credit assessment, assessment just once at the beginning of 30 years;
• instead of having mandatory cash calls for any change in your home equity at the end of each year, never having a cash call for declines in your home equity;
• instead of being vulnerable to changes in the supply of credit, being guaranteed the same terms as long as you stay current on your payments.

Of course, just as with a delayed variable annuity, each of these riders comes at a cost, generally in the form of higher interest rates.

Once you know you're paying for each rider, you could decide which ones are worth paying for

What got me thinking about this most recently was seeing the statistic that the median length of tenure in single-family owner-occupied housing is 15 years (6 years for multi-family condo owners). In other words, 50% of single-family homeowners move before spending 15 years in their home. But between 85% and 90% of mortgages are for 30 years. That means 35-50% of home buyers are paying for riders they don't use: fixed interest rates and payments and credit insurance for the second 15 years of their mortgage.That begs the question: do the 50% of homeowners who move within 15 years know in advance they'll move within 15 years? If so, they're overpaying for those 15 years; they'd be strictly better off with a 15 year mortgage (even if that meant a balloon payment in year 15, by which point they plan to sell the house anyway). If not, what they're paying for is an insurance policy so that if they end up belonging to the 50% that stays longer than 15 years, they won't have to renegotiate new terms and be susceptible to intervening changes in the credit market.That insurance is worth something, without a doubt. But the price is higher interest payments and lower principal payments during each of the first 15 years. By saving that money instead, home buyers could "self-insure" against the same risk, with the potential upside of being able to keep the savings if they do, in fact, move before then.

The problem with the federal housing finance agencies is that they subsidize one particular set of riders

On the one hand, the idea of securitizing standardized mortgages and making it possible for investors to select the particular borrower and loan characteristics they are looking for while freeing up bank capital to underwrite and issue new loans is a fairly reasonable idea. On the other hand, the private sector has demonstrated absolutely no interest in doing so, and it was left up to the federal government to create the so-called "government-sponsored enterprises," or GSE's (the failure of the GSE's in 2008-2009 suggests one possible explanation of the reluctance of the private sector to undertake this enterprise).The problem is not that the government has decided to subsidize homeownership. The problem is that doing so has made offering unsubsidized mortgages uneconomical, since mortgages that don't qualify for sale and securitization have to be held on the lender's books or privately securitized (i.e. without an implicit government guarantee), tying up that capital until the loan is repaid, while qualified mortgages can be immediately sold and the same money lent again to another borrower, with a new set of origination fees piled on top.Freddie Mac has this fairly hilarious document signed by their "VP Chief Economist" Sean Becketti explaining that:

"The considerable benefits of the 30-year fixed rate mortgage to consumers are beyond question. However, this type of mortgage isn't a natural fit for lenders. All the features that benefit the consumer—long term, fixed interest rate, and the option to prepay the loan without penalty—create serious headaches for lenders. As a result, the federal government created Freddie Mac and other institutions that allow lenders to hand these headaches over to the capital markets, where sophisticated portfolio managers have the tools and expertise to manage the investment risks of the 30-year mortgage."

Now, 15-year (and shorter) fixed-rate and floating-rate mortgages are still available, and under the right circumstances may even be qualified mortgages for securitization purposes. But balloon loans, which require repayment or refinancing in the final year of the mortgage, are decidedly verboten. In other words, for a mortgage to be qualified for GSE securitization, it has to be repayable in equal payments over the term of the mortgage, which in practice forces people who have no intention of staying in their home for 30 years into 30-year mortgages — and paying the correspondingly higher interest rates for each of the years they actually remain in the home.

Disclosure

I own 50 common stock shares of Freddie Mac and of Fannie Mae. I've lost about $150 on them since I bought them, but remain hopeful that the current administration will sell out the American public by allowing the GSE's to recapitalize and start paying dividends again, in which case I'll make a fortune.

How Ron Johnson’s weird idea for corporate tax reform might work

Senator Ron Johnson of Wisconsin announced last week that he couldn’t support the Senate tax reform bill because it failed to align the treatment of corporate income (which is taxed once when it’s recorded as profit and again when distributed to shareholders) with “passthrough” income, which is taxed only when it is reported on an individual taxpayer’s return. Rather than trying to align the total tax paid on the two forms of income through crazy schemes of allocating certain income to capital and other income to labor, Johnson’s preferred approach is to tax all business income as passthrough income.This is a surprisingly good idea, and if you have the political will to radically reform the tax system it has a lot of advantages over the current Republican proposals. However, implementing it would require a lot of interlocking changes in order to more-or-less replicate the total taxes we levy on corporate profits today. Here’s how I would set up such a system.

Tax dividends and capital gains as ordinary income

Today taxes are paid on corporate profits once at a rate up to 35%, then again on qualified dividends and long term capital gains at a preferential rate of between 0% and 20%. That means the total tax collected on a corporation's profits theoretically ranges from 35% to 55% depending on the precise composition of the corporation’s shareholders: if a corporation happens to have a disproportionate number of shares owned by low-income taxpayers, tax-free or tax-deferred savings vehicles, and untaxed endowments, its profits will be taxed less than a corporation with a disproportionate number of shares owned in taxable accounts by high-income taxpayers.Since the point of Johnson’s proposal is not to privilege one business structure over another, you would want to strip out that difference by taxing all corporate distributions at ordinary income tax rates. Otherwise, profits distributed to low-income shareholders would never be taxed at all (because of the preferential 0% capital gains rate), while high-income taxpayers would see a 64% cut in the taxes they pay on corporate profits, since they would only pay taxes on profits once, at the 20% rate.If a business's profits ultimately belong to the business’s owners, applying the same progressive income tax rates to business income as we do to labor income makes perfect sense: low-income business owners will pay lower income tax rates on their combined labor and capital income, and high-income business owners will pay higher income tax rates on their total income, without the artificial floor created by the corporate income tax.This also has the advantage of obviating the need to distinguish “active” and “passive” ownership, since income, rather than ownership, would become the basis for taxation.

Impose an excise tax on corporate profits distributed to foreign shareholders and endowments

Similarly, if corporate profits were distributed to foreign shareholders without being taxed at the corporate level, they would never be taxed at all, so you’d need to impose an excise tax of 30-40% on corporate profits distributed to non-US persons in order to not create a massive distortion in the ownership of US assets. Presumably our hardworking diplomats could hammer out the details in tax treaties to include reciprocal treatment of such income so foreign shareholders aren’t punished for investing in US companies, and vice versa.A similar logic applies to untaxed foundations and endowments. Currently their income from corporate ownership is taxed when the corporation records it but not when it’s distributed to them; levying a roughly 35% excise tax on such distributions would keep such entities from shielding corporate profit from taxes indefinitely.

Lower the estate and gift tax exemption

The extremely high estate and gift tax exemptions we have today mean that assets in tax-deferred savings vehicles are only taxed once, at the corporate level, and then never taxed again as their distributions and appreciation accumulate before being transferred to heirs tax-free. If we eliminated the tax on corporate profits, then those profits would never be taxed at all. This may be reasonable for small inheritances in order to avoid the administrative hassle of filing estate tax returns, but lowering the exemption to $500,000 or $1,000,000 would ensure that as much untaxed corporate profit as possible is eventually recorded. This could be even paired with a lower rate for smaller estates which are less likely to engage in the elaborate tax planning extremely wealthy shareholders have access to, and therefore more likely to have paid taxes at some point on the corporate profits they contain.You can imagine achieving a similar result by eliminating the stepped-up basis rule but that approach would be much more administratively complex and we’re trying to simplify, not complicate the tax code!

Conclusion

This is one combination of policies that would achieve the dual objectives of treating business income equally regardless of the legal structure the business uses to organize and raising roughly the same amount of revenue from capital income as we do today. I suspect that if completely implemented this combination of policies would in fact raise an enormous amount of revenue which could be used to cut the marginal tax rates paid on all forms of income (if you were so inclined).So, hand it to Ron Johnson: he may not have any idea what he’s doing in the Senate, but the idea of equalizing corporate income taxation with passthrough income taxation makes a hell of a lot more sense than the attempts in the House and Senate to do the opposite.

What's the optimal amount of home-country (currency) bias?

I have the view, which I consider fairly obvious but not always clearly articulated, that virtually all low-enough-cost, adequately-diversified investments will yield positive nominal returns over the appropriate investment time horizon. If you own yen-denominated Japanese bonds, you should expect to receive a positive yen-denominated return over the term structure of the bonds. If you own euro-denominated stocks, you should expect to receive a positive euro-denominated return over the (potentially infinite) time horizon of your equity investments.There are exceptions. If you're a yen-denominated investor who inherited a fortune on December 31, 1989 and immediately invested it in a Nikkei 225 index fund (I'm not sure such a thing existed at the time, but bear with me), then even with dividends reinvested your fortune today would still be somewhat smaller in yen than it was on that date. Likewise communist upheavals and sovereign defaults have completely wiped out bond investors at various intervals around the world.Diversification is a sensible way to secure part of the return of various global assets classes with unknown (but presumably positive) nominal growth, while reducing the risk of total loss in case of war, communism, or default. It is so sensible, in fact, that I think people can get a bit too enthusiastic about its merits. That's because diversifying internationally reduces your concentration risk but adds a new risk, currency.If yen-denominated assets rise by 6% a year but the yen declines by 6% per year against the dollar, you'll enjoy positive yen-denominated returns but flat dollar-denominated returns. That's a big deal if you plan to retire to a country that sells goods and services in dollars!

Home country bias

"Home country bias" refers to the tendency of investors to allocate a disproportionate amount of their capital to domestic assets. That begs the question, "disproportionate" compared to what? To say an investor allocates "too much" capital to a given country implies there's also a correct amount to be allocated there.Two ways you might define an "unbiased" asset allocation are by the market capitalization of a country's investable securities, or the share of global economic activity in a given country. A market capitalization approach has the advantage of automatically rebalancing over time as markets rise and fall in value, while an economic activity-weighted allocation would need to be manually rebalanced since a country's rising or falling share of economic activity may or may not be reflected in its market capitalization.A market capitalization-weighted portfolio would hold about 36% in US equities and 64% in international equities, while an economy-weighted portfolio would hold somewhat less in US equities, perhaps 25%. If you hold more US equities than whichever you think is the "real" benchmark, then congratulations, you have home country bias!

It makes sense to be overweight the currency you intend to spend

Most people, in most of the world, are born, grow up, and die in the same country. That means most people's income and expenses are denominated in the same currency.This general rule is not, however, universally observed. While I was there, Russian banks offered certificates of deposit denominated in rubles, dollars or euros, with different interest rates depending on the currency you chose (ruble deposits paid the most). Likewise in Europe we recently saw the revaluation of the Swiss franc punish Polish homebuyers whose income is denominated in zloty but who took out franc-denominated mortgages to take advantage of lower interest rates.If international diversification is a way to reduce the risk of concentrated bets on a single country, then home country bias is a way to reduce the risk of exchange rates moving against you. Most large-country exchange rates are mostly stable most of the time. But as the Poles learned, you also don't want to be left holding the bag if the currency you intend to spend suddenly gets much more expensive.What this logic means is that you should be biased not towards your home country, or even your home currency, but rather the currency where you intend to spend the value of your investments — and you can be biased towards different currencies for different reasons!For example, a 529 plan you intend to liquidate to pay for an education in the US might be biased towards US stocks and bonds, while a retirement account you intend to use to retire in the Eurozone might be biased towards euro-denominated stocks and bonds. In the one account you're protecting yourself from a stronger dollar, which would raise the price of US higher education in non-dollar-denominated assets, while in the second you're protecting yourself from a stronger euro.

What's the optimal amount of home-currency bias?

The funny thing about home-currency bias is that it tends to provoke absolutism in people. If you believe that home-currency bias is an investor "error" and that it should be eliminated completely, you arrive at the strange view that everyone in the world should have the same asset allocation (at least within their stock and bond "buckets"). A Greek, Chinese, Polish, Canadian, Ecuadorean, and US investor should all hold 36% of their stocks in a market-cap-weighted US mutual fund and 64% in a market-cap-weighted international fund.On the other hand, Jack Bogle's view has long been that international investing is unnecessary for US investors. US companies do business all over the world, so you get the same currency and economic risk exposure you would get by investing in international companies directly.I think the right answer is not 100% home-currency bias or 0% home-currency bias, but rather the terribly unsatisfying "some home-currency bias." To the extent that your future expenses are predictable, shading your asset allocation to the currencies those expenses are denominated in makes perfect sense. If you have a Swiss franc-denominated mortgage, you should be "overweight" franc-denominated assets (or save up several years worth of mortgage payments in francs). If you plan to send your kids to US colleges, you know for a fact those expenses will be high and dollar-denominated, so logically those savings should be overweight US dollars.

What if you can pick the currency your expenses are denominated in?

So far I've been talking about future expenses that are denominated in a known currency. You know as soon as you sign the paperwork what currency your mortgage payments will be in, and US colleges and universities only accept US dollars. But not all expenses are like that, or at least they don't have to be. You don't have to decide which currency to retire in until you're ready to retire. Then you can consult the latest edition of the Economist's Big Mac index and move to the country with the most undervalued currency.To the extent that you can pick the currency your retirement expenses will be denominated in, then your goal should logically be to maximize the dollar-denominated value of your portfolio (the one that appears on your statement). If the dollar falls in value, you can stick around in the US where our goods and services are dollar-denominated, while if it rises in value, you can pick the retirement destination of your choice. In that case, you really might want to eliminate home country bias in your equity portfolio because you aren't exposed to the same exchange rate risk.You can apply the same logic to education expenses. If international institutions get cheaper in dollar terms, you can ship your kids overseas, while if they get more expensive, well, US colleges will continue to accept your worthless dollars.

Conclusion

One reason it's hard to think clearly about currency risk is that if you work with a US brokerage, your account's value is only shown to you in US dollars, so it's difficult to keep in mind that the value of your portfolio can rise in dollars while falling in another currency (if that currency appreciates relative to the dollar), and vice versa.Obviously anybody can look up current exchange rates and calculate the euro-denominated, ruble-denominated, or zloty-denominated value of their portfolio whenever they want, but I have long though it would be a cool feature for a brokerage to automatically calculate and display your account's value and its change in value in 3 or 4 major currencies.I know my portfolio's value has risen in US dollars, and I know the US dollar has fallen compared to the Swiss franc. Which effect is larger? Have I grown wealthier or poorer in Swiss francs? I think that would help people think more clearly about currency risk, and perhaps even improve their ability to design an investment portfolio that targets returns in the currency they actually intend to spend.

Indexed annuities are bad

To call the finance industry a "mixed bag" would be a gross understatement. There are a few functions essential to industrial capitalism that banks, bill brokers, and financiers mastered centuries ago, like moving funds from savers to borrowers, a process described marvelously by Walter Bagehot in 1873. Then there's the constant stream of financial "innovations," as bankers churn out new and exciting products to separate people from their money — and that's when they're not simply robbing their customers.The problem with financial innovation is that there are only a few fundamental functions a financial company can perform. For example, an insurance company can spread the risk of an early death across a population by selling insurance to every member of population, moving money from those who survive to the survivors of those who live. A bank can make you a loan today that will be paid back with your future income, in effect "accelerating" your salary by moving it forward in time. A bank can borrow money from you today, promising to pay it back over time, while giving the money in a lump sum to a borrower.What the finance industry can't do is create value. You may be grateful to a stock broker for facilitating a profitable trade, but any trade that's profitable for you is unprofitable for the guy on the other side of it. You may be glad to loan your money to the bank for interest, but the guy borrowing the money would surely rather not pay interest on his loan. The finance industry simply rests in the middle, taking a cut of every transaction.

Indexed annuities make no sense

I have to assume these products will be banned eventually since they are marketed and sold in extremely abusive fashion, but for now, here's how they work. A fixed annuity is combined with an index (for example the S&P 500), so that the value of the annuity contract is adjusted according to the performance of the index.Usually the value of the contract is adjusted upwards annually or biannually according to the change in the value of the index since the last adjustment date, up to a maximum adjustment amount, typically between 3% and 6%. If the index rises by more than that, you get the maximum adjustment but no more. If the index declines between adjustment dates, the value of the contract isn't adjusted downward.There are three big problems with this product:

• Maximum adjustment. If the insurance company buys options against the relevant index in order to hedge against changes in the contract's value, and the index rises by more than the maximum adjustment amount, the insurance company gets to keep any profit it shows on the options' value.
• Dividends excluded. If you were to own the relevant index itself, instead of an annuity indexed against it, you would also earn any dividends paid by the stocks in the index. Reinvested dividends and bond coupons represent a significant part of any investment's return, and you give them up when you buy a price-indexed annuity.
• High fees. In exchange for giving up "excess" price appreciation and the dividends paid by the underlying index, you also get to pay your insurance agent a commission several times higher than the one on an immediate fixed annuity. The same premium mechanically has to buy a smaller annuity if more of it is going to pay commissions (remember, finance doesn't create value).

Michael Kitces has a good post focused on the idea of principle protection and equity participation, which is, in principle, the "problem" variable indexed annuities were designed to address. But of course the purpose of annuities is not principle protection and equity participation — it's to provide a stream of lifetime income!

Single premium immediate annuities make a lot of sense

Today it's very fashionable to talk about "sequence of return" risk: a retiree might expect their investments to return 6% per year on average over the next 30 years, but if the first 15 years return -6% and the second 15 years return 18%, the 30-year average doesn't do them any good since they won't have any assets left by the time the 15-year bull market comes along.It's not a terribly popular view, but I think annuities are a perfectly reasonable way to foist sequence of return risk onto somebody else.Most US retirees' income will consist entirely of their Social Security old age benefit, which is why their first priority should be maximizing that benefit by delaying their old age benefit as long as possible, even if it means spending down their retirement savings before filing.But for retirees with expenses in excess of their Social Security benefit, buying a single premium immediate annuity is a sensible way to achieve a guaranteed income that meets those needs.

Just buy the annuity you need

There's a simple rule of thumb in annuity pricing: the more you want your annuity to resemble an investment, the smaller the annuity will be, or the more you'll have to pay for it. But investing is cheap and easy! Don't pay insurance agents and insurance company shareholders a premium to do something you can do yourself for next to nothing.Figuring out your lifetime retirement expenses isn't "easy," but it's possible. You can even pay a real, professional, fiduciary financial adviser to help you out while calculating those expenses, instead of an insurance salesperson who's paid more depending on the amount they can convince you that you need.Once you have a sense of your annual expenses in retirement, you can deduct your Social Security old age benefit and buy an annuity that makes up the difference. It doesn't matter to me what you do with the difference: you can leave it to your heirs, give it to charity, or buy ornamental bookends. All I want is for you to not pay for "protection" you don't need given your actual expenses and actual net worth — however much those end up being.

Five questions about tax "reform"

Back during the Affordable Care Act repeal debate I wrote pretty extensively about the threat repeal posed to entrepreneurs and entrepreneurship by preventing self-employed people from being able to sign up for affordable, comprehensive health insurance.Instead of the doing the same thing for the House and Senate tax "reform" bills, I thought I'd take a different approach and throw out a few broad areas to keep an eye on as these bills are negotiated and debated.

How much will corporate tax reform add to the deficit?

There's no doubt that America's corporate tax system could be reformed by eliminating preferential treatment of certain expenses ("loopholes") and using the resulting revenue to reduce the maximum statutory rate, if we were inclined to do so.That is not, however, the Republican corporate tax reform plan. Instead, they plan to make modest changes to corporate tax law, radically reduce the top statutory rate, and exclude foreign earnings from taxation.This accounts for the overwhelming majority of the cost of the GOP plan, so any changes or delays in this part of the bill will make a big difference. A 25% rate instead of the proposed 20% rate, for example, would reduce the impact on the deficit substantially, as would a decision to continuing to tax foreign earnings at the maximum statutory rate instead of a special lower rate on overseas or global activity.

How will repatriated profits be handled?

It's often said that US corporations "can't" repatriate their foreign earnings because of the taxes they would have to pay on them. It would be more correct to say that US corporations have been instructed by the Republican Party not to repatriate their foreign earnings and instead wait until Republicans are able to permanently exempt them from taxation.If they're able to do so again (there was an earlier repatriation holiday under George W. Bush), it will reinforce the conviction in US boardrooms that they should accrue, on an accounting basis, as much of their earnings as possible in overseas tax havens, until the next opportunity comes around to repatriate them tax-free.

How will passthrough income be handled?

Currently, passthrough business income is taxed at the recipient's individual tax rate, and is fairly simple to handle on an IRS Form 1040 once you get the hang of it. Will a parallel tax system be created that taxes part of passthrough business income as earned income and part as capital income? If so, how hellishly complicated will that parallel system be, and what kinds of firms will be subject to it?From a revenue standpoint this discussion has focused on large passthrough enterprises like real estate investors and hedge funds, but the overwhelming majority of US businesses are organized as passthroughs, so introducing unnecessary complexity here would be a massive penalty on small business formation and a direct attack on entrepreneurs and entrepreneurship.

How are deductions changed?

There are three moving parts to keep an eye on when it comes to income tax deductions:

• the standard deduction and individual exemption;
• non-itemized deductions;
• itemized deductions.

Raising the standard deduction has two effects: it increases the amount of money low-income filers have completely exempted from federal income taxation (note as always that FICA taxation starts with your first dollar of earned income) and it reduces the value of itemized deductions since only itemized deductions in excess of the standard deduction reduce filer's owed taxes.Non-itemized deductions are available to everyone regardless of whether they itemize deductions, but that means they also complicate everyone's tax filing process. For example, Line 26 on Form 1040 is simply labeled "Moving expenses. Attach Form 3903." Since I move fairly frequently, almost every year I have to dig up Form 3903, then complete the "Distance Test Worksheet," then check if I meet the "Time Test," then find out I don't qualify (I've never qualified). Eliminating these deductions is unpopular because they all have appealing-sounding names (although Line 24 "Certain business expenses of reservists, performing artists, and fee-basis government officials. Attach Form 2106 or 2106-EZ" needs a press agent) and you can always find a journalist willing to express outrage over eliminating them. I would personally encourage you to resist that temptation.Itemized deductions, unlike non-itemized deductions, are only available if you don't take the standard deduction. This means they're only claimed by people with deductible expenses in excess of the standard deduction. Raising the standard deduction would mechanically reduce the number of people who find it worthwhile to file tax returns with itemized deductions, but focusing on the number of people who actually itemize deductions on their tax return misses the much larger number of people who are forced to calculate whether or not to itemize deductions. Eliminating itemized deductions entirely would be the best approach to tax simplification, but any deductions that are eliminated would constitute an improvement over the status quo by reducing the number of people who are forced to calculate their taxes twice.

How are credits changed?

Here are the Form 1040 tax credits I consider eligible for elimination (there are a few more that work as adjustments to payments made during the year that I'm not including here):

• Credit for child and dependent care expenses;
• Education credits from Form 8863;
• Retirement savings contributions credit;
• Child tax credit;
• Residential energy credits;
• Earned income credit (EIC);
• Nontaxable combat pay election;
• Additional child tax credit;
• American opportunity credit;
• Credit for federal tax on fuels.

If anything these credits have even more appealing names than the deductions I mentioned above, and they elicit even more passionate defenses from the journalists covering this debate.

Conclusion

You can come to your own conclusions about the proper way to go about reforming our tax code. The current proposals cut taxes on corporations by about $2.5 trillion and raises taxes on individuals by about $1 trillion over the next ten years. Another approach might be to make corporate tax reform deficit neutral and individual tax reform deficit-neutral, paying for corporate rate cuts with corporate loophole repeal, and paying for individual rate cuts or refundable credits with individual deduction and credit repeal. Yet another approach could raise taxes on corporations in order to reduce the taxes paid by individuals.But whichever outcome you personally favor, hopefully these five questions give a sense of where the bodies are buried in the current tax reform debate.

On mutual understanding

I think that, to a degree that sometimes seems unusual in these heated times, I enjoy reading and listening to people who don't just disagree with me, but fundamentally disagree with me.This is partly because I don't even agree with the people who agree with me, so I get annoyed whenever a Democrat suggests a new means-tested tax credit and I see in my mind's eye the dozens of pages of forms and instructions unfolding before me (see, e.g., Second Lowest Cost Silver Plan, and IRS Form 8962).But it's also because if you listen to people in their own words, they're often making somewhat different arguments than the ones that your own ideological filters pass along to you. Not necessarily good arguments, or bad arguments, just different ones.For example, conservatives in the United States will often pretend to make arguments in public about the size of the US national debt in order to justify their opposition to policies that make healthcare, childcare, or retirement affordable to their fellow citizens. When they do so, progressive media outlets inevitably take great pleasure in pointing out that the size of the US national debt poses no obstacle to conservatives passing enormous deficit-financed tax cuts. This is all very fun and gets people very excited but I think represents purely empty calories of self-righteousness. Since the Republican party does not, in fact, care about the size of the national debt, there are no "gotcha points" in "catching" them not caring about the size of the national debt.On the flip side I think conservatives are quite ill-served in general by their captured media outlets, but when it comes to issues like the North Carolina restroom-access law you see this starkly elevated, with the view being imputed to liberals something along the lines of "Democrats want sexual predators to kill your children." This is, needless to say, not something Democrats want.In other words, you can learn a lot more about your ideological opposition's views by listening to them, instead of listening to how your ideological allies filter their views back to you.As a fire-breathing leftist, I can tell you that I support legally entitling people to use the bathroom that corresponds to their gender identity so that people are not faced with the absurd situation of being thrown out of one restroom for dressing or looking the wrong way or the other restroom for having the wrong anatomy. Given the extremely high level of violence in American society, policing, and criminal justice, explicitly protecting people in such vulnerable situations seems like common sense to me.Likewise, when I read conservatives describing, in their own words and to each other, their objections to Democratic governance, I don't see any indication they are concerned that large amounts of deficit spending will cause interest rates to rise, crowding out private investment (the ostensible economic objection to running large and growing deficits). How could they, given that the Republican party just committed itself to increasing the 10-year deficit by $1.5 trillion? "Catching" people not holding a view they obviously don't hold doesn't have any appeal to me. Rather, in the view of conservative writers, Democratic governance is supposed to be dedicated to the idea that the overall size of the economy can and will be sacrificed in order to give a larger share of a smaller pie to Democratic voters. The preferred Republican alternative is a rapidly growing economy in which an arbitrarily large share of economic growth is accumulated by the wealthiest owners of capital.

Conclusion

This is not an argument that you should "change your mind" or "keep an open mind." I don't think I keep a particularly open mind, and I struggle to remember the last thing I changed my mind about. Rather, it's an argument to try to meet people where they are. If you think Democrats want to station sexual predators in your restrooms, you're not going to have a very generous view of their suggestions for zoning reform. If you think Republicans are relentless hypocrites on deficit spending, you're not going to have a very generous view of their proposal to limit the mortgage interest deduction.But I continue to think that, as a rule, good policies are worth adopting and bad policies are worth rejecting regardless of which ideological quarter they come from. It would, at least, be worth a try.

The low-hanging fruit of personal finance

On Friday I wrote about how people making payments in excess of the minimum to student loans need to make sure their student loan servicers have instructions to credit the excess payments to their highest-interest-rate loans first. It's the kind of simple measure you can take to save money on student loan interest, and all it takes is a single letter to put the appropriate instructions in place.It's also the kind of simple measure I'm confident virtually no student loan borrower takes.That got me to thinking: what are the other low-hanging fruit of personal finance? What are the simplest things you can do to improve your financial well-being, broadly considered?Here are a few more that I came up with.

Maximize the interest your cash earns

I love cash. I don't think you need to justify holding cash by calling it an "emergency fund" or pretending to save for a house down payment or car repairs or whatever. Cash is great and it doesn't need any excuses. But if you're going to hold cash, you should want to earn the highest possible return on it. That means ignoring the "high-interest" savings accounts offered by Discover, American Express, or your local bank and going straight to the highest-interest checking accounts, like the Consumers Credit Union Free Rewards Checking account.You can earn 3.09% APY on up to $10,000 by buying 12 $0.50 Amazon credit reloads each month with your Consumers Credit Union debit card.If you want to earn even more interest on even more money, you can sign up for one of the Consumers Credit Union Visa credit cards and earn 4.59% APY on up to $20,000 by making the same 12 Amazon credit reloads and spending $1,000 on the credit card each month.The Amazon credit reloads take 5-7 minutes on the first of each month. How's that for low-hanging?

Be fully invested (in something)

When it comes to investment accounts, particularly accounts that feature tax-free or tax-deferred growth, you will probably be ill-served leaving large amounts of cash in your account's default settlement fund. Even if you don't want to invest in equities at their current or future valuations, you can direct contributions to a short-term inflation-protected bond fund, or even just a money market fund offering slightly higher yields than your brokerage's default settlement fund. As with student loan interest, it's the kind of small election that has the ability to earn you much higher returns with virtually no effort.

Use the right credit cards

My other blogging project is dedicated to the very high-hanging fruit of maximizing credit card rewards, but that is a hobby that consumes an enormous amount of time and attention. If you don't want to do that, you don't have to. Instead, you can use these simple rules to pluck the lowest-hanging credit card fruit:

• Earn at least 2% cash back on all your purchases.
• Don't pay foreign transaction fees.
• Don't pay annual fees.
• Use balance transfer offers to minimize the interest you pay on ongoing credit card balances.
• Use introductory financing offers to minimize the interest you pay on new credit card balances.

Debt moralizers will tell you that credit card rewards, balance transfer offers, and introductory financing offers are traps to get you to fall into debt. Maybe they're right!But I don't care whether you're in debt or not, I care whether you're paying interest on your debt or not, and my concern is that most people, most of the time, are paying too much in credit card interest.

Make good behavior easy and bad behavior hard

Behavioral economics is all the rage these days, and the economists are hard at work testing all sorts of rules and defaults to get people to save more, eat better, smoke less, and whatever else they think is best for us. Good luck to them, I suppose.But in your own life, you don't need a marionettist to pull your strings: you can pull your own strings, by automating as much as possible the behavior that you, personally, recognize as good and necessary, and staying out of your own way.Set up automatic contributions to investment accounts. Reinvest automatically. Rebalance quarterly at the most frequent; annually is probably fine. Delete your investment accounts from Mint, Personal Capital, and any other tools you use to track your finances. If seeing your balances bounce up and down is making you exhibit behavior you know to be bad, the answer is as simple as not seeing your balances bounce up and down.If you're a compulsive gambler like me, give yourself a small amount of cash to gamble with using a free trading app like Robinhood. Treat the money as gone as soon as you invest it, and then have fun buying and selling stocks as much as you'd like — especially when you get the temptation to mess with your actual investment portfolio.

Open a solo 401(k) if you have self-employment income

A solo 401(k) is an important tool for self-employed people for a few big reasons:

• You can make pre-tax employee contributions if your employer doesn't offer a 401(k) at your day job, or if their 401(k) provider offers inferior investment options.
• You can make pre-tax employer contributions even if you've already maxed out your employee contributions at your day job.
• You can make post-tax employee Roth contributions if your employer doesn't allow them at your day job.
• You can choose your own 401(k) custodian if the custodian your employer uses at your day job is terrible.

Now, I agree this may not seem like "low-hanging fruit," but if your small business is an unincorporated sole proprietorship you don't have to actually do anything throughout the year once your solo 401(k) is up and running. While you're calculating your taxes, just figure out how much you need to contribute to your solo 401(k) to get your income where you want it to be, and make the appropriate combination of pre-tax employer and post-tax employee Roth contributions.Things are somewhat more complicated for small business that have made an "S corporation" election, which is one reason I'm more skeptical of S corporation elections than some small business owners.

Trigger your employer's matching 401(k) contributions

This is the most boring of my low-hanging fruit suggestions (which is why it's last), but it's still good advice: if your employer matches any part of your elective 401(k) contributions, make at least the minimum required elective contribution to maximize the employer's match.I don't think much of employer-sponsored 401(k) plans as a rule due to the high-cost, conflicted investment options they frequently offer.On the other hand, I think very highly of free money. If you make at least the contribution necessary to maximize your employer's match, you can leave the money in cash and still walk away with a guaranteed tax-deferred rate of return that's difficult to imagine getting elsewhere.

Conclusion

What's your favorite low-hanging fruit of personal finance, and just how low-hanging do you think it is?I think people have a natural tendency to treat the things they think of as fun and easy as intrinsically fun and easy. It's a tendency that, as you get older, you hopefully start to realize has no connection to reality.So which of my suggestions do you think is preposterously complicated and which is so simple it doesn't even bear mentioning?

On compound interest (and peeking)

There's no subject personal finance bloggers love gushing over more than compound interest. Conjure up a conveniently "assumed" rate of return, give it a few decades or a few centuries, and presto, you're worth more than Warren Buffett.The thing about compound interest, though, is that it doesn't work over long time periods, it works over many time periods. I was riffing on Twitter the other day about the "sideways" stock market that had nonetheless doubled in the last 5 years, and suddenly wondered: what would a steadily compounding investment portfolio look like in real time?The answer, which is obvious after a few moments of reflection, is it would look completely and utterly boring.Imagine a diversified portfolio of stocks and bonds that you expect to compound annually at 6% APY for 30 years, which I treat as the maximum realistic return to expect from such a portfolio. This would result, in 30 years, in a portfolio that's about 5.7 times as large as your starting investment. The magic of compound interest, etc.Then imagine that rather than the actual rollercoaster of the stock and bond markets, the value of the portfolio rose steadily each and every day for the entire 30 years. What would that look like in real time?

• If you checked the value of your portfolio each of the 252 days the US markets are open each year, you would see it rise by 0.02% per day.
• If you checked the value of your portfolio each of the 52 weeks in the year, you would see it rise by 0.11% per week.
• If you checked the value of your portfolio each of the 12 months in the year, you would see it rise by 0.49% per month.
• If you checked the value of your portfolio once a year for 30 years, you would see it rise by 6% per year.
• If you checked the value of your portfolio each of the decades in 30 years, you would see it rise by 79% per decade.
• And if you check it just once at the end of 30 years, you'd see it rise by 570%.

Don't peek, but if you do peek, know how to interpret what you're peeking at

Jack Bogle deserves — and receives — all the credit in the world for making low-cost, tax-efficient indexed investment vehicles available to retail investors.But you've also got to pay respect to Bogle's investment aphorisms, my favorite of which is "don't peek." When your brokerage statements arrive, Bogle wants you to throw them in the recycling, unread.Then "when you retire, open the statement and believe me if you've been putting money in there for 40 or 50 years, you'll need a cardiologist standing by you when you open it."Now, you're probably not going to do that. I certainly don't do that (I don't even know any cardiologists). I check my account balances every day, like some kind of digital Scrooge McDuck.But if you open up your Vanguard account at the end of each day to see "how you did" and your balance has increased by 0.02%, it hasn't "moved sideways," it isn't "flat," and it isn't "uneventful."It's compounding at 6% APY — let it!

One weird old trick to save money on student loan interest

Back in September I wrote about how structuring your borrowing and investing decisions properly in the first place is superior to continually trying to optimize and re-optimize them. However, there's an important corner case where you're able to optimize your post-borrowing behavior, and that's the case of student loans.Depending on a number of factors including the prevailing student loan interest rates when you were enrolled, the number of years you took to graduate (or drop out — we don't judge around here), and the student loan repayment regime when you were enrolled, you might have a number of federal and private student loans with different interest rates and different repayment options.For loans which are eligible, I'm the world's biggest proponent of "income-based repayment," or IBR. Your payments are capped at a percentage of your income, and any remaining balances are forgiven at the end of the IBR repayment period.However, folks who know they won't be eligible for IBR loan forgiveness (or the public service loan forgiveness program) may understandably want to accelerate the repayment of their student loans. That impulse may become even more tempting if the Republican Party succeeds in their effort to repeal the federal income tax deduction for student loan interest, which would almost double the after-tax cost of student loan interest for high-income borrowers.

Send your student loan processor written instructions on how to process payments in excess of the minimum

Thanks to the consolidation of the federal student loan program under President Obama, there are relatively few student loan servicers today, but each has somewhat different methods of processing payments in excess of your monthly minimum owed.If you don't know how your student loan servicer processes excess payments, you may be shocked (or disgusted) to learn that they are not required to apply payments in excess of your monthly minimum to your highest-interest balances. They are, legally, free to apply excess payments to your loan balances in any manner they choose — unless you instruct them otherwise.So, instruct them otherwise! The Consumer Financial Protection Bureau has produced a draft letter you can use to specify exactly how excess payments should be applied to your student loans. Read it carefully, fill it out with your own personal information and preferences, and send it by certified mail to your loan servicer. Then check with them in 10-14 days to make sure they've received and applied your instructions to your account.

401(k)'s are a bad idea, poorly implemented, that doesn't and can't work

Status quo bias is one of the most powerful forces in American political life, and to overcome it a party or faction usually requires some combination of internal unity, lobbyist and interest group solidarity, and, if push comes to shove, popular support among the voters they're ostensibly in Washington to represent.The current Republican push for "tax reform" does not appear to enjoy any of the above pillars of support, so I would very slightly shade the odds against the passage of a tax reform bill this year (no, I'm not taking bets, I got burned once already last November). Nonetheless, what has been truly remarkable to watch is the interest groups coming out of the woodwork to defend the most indefensible parts of the current tax code. Even worse has been seeing their arguments passed along by journalists as if they were objective observers making good faith arguments, and not just folks trying to protect their own interests by any means necessary.I follow the financial press closely enough to see, in the last few weeks, an outpouring of handwringing about the briefly-mooted suggestion that Republicans would drastically reduce the amount of pre-tax payroll that could be contributed by employees to 401(k) plans. The only problem with this proposal is that it doesn't go far enough: 401(k) plans are a plague, and getting rid of them completely can't come soon enough, within or without the context of tax reform.

Giving employer-sponsored benefits tax privileges is bad

While this argument has traditionally focused on the exemption of employer-based health insurance plans from taxable income, it's equally relevant to retirement savings programs. I don't have an objection to employer-based retirement savings programs any more than I have objections to employer-based health insurance programs.My objection is to privileging such programs in the tax code, leaving the employees of organizations which do not sponsor retirement or health insurance schemes, and the self-employed, with the duty to pick up the tax burden avoided by those firms that do so.

Employers are not good at administering 401(k) programs

The quality of the 401(k) programs administered by employers varies both qualitatively and quantitatively:

• Employers hire different management firms with access to different fund families with different cost structures;
• Employers accept kickbacks from investment management firms because, due to a legislative drafting fluke in ERISA, only fund management, not fund selection, decisions are required to be made with employees' best interests in mind;
• Employers have different plan rules, with some allowing and some disallowing loans, some allowing and some disallowing in-service rollovers, etc.

Even if you believe that savings by workers during their careers is essential to retirement security when they stop working, why would you put this responsibility in the hands of employers who have no interest or demonstrated ability to fulfill it?And what would you do about those employers who have no interest in even trying to fulfill it?

Brief aside: my favorite episode of 401(k) apologetics

The genre of 401(k) apologetics is diverse and beautiful, but I have to point out my single favorite entry in the genre. MarketWatch recently published the following passage without a trace of embarrassment:

"This year, the maximum pre-tax contributions an employee can make to a 401(k) plan is $18,000, and next year will be $18,500. (Some plans allow for additional after-tax dollars to be contributed as well). But it would be nice for employees if these contributions were even higher, said Rose Swanger, a financial adviser at Advise Financial in Knoxville, Tenn. Only about 10% of Vanguard participants maxed out their 401(k) contributions in 2016, according to an analysis by the Center for Retirement Research at Boston College, down from 12% in 2013, but the option could be encouraging for people who do not understand the scope of how much they need for their retirements [emphasis mine]."

Did you follow the logic here? Since only 10% of employees maximize their contributions, therefore the contribution limit should be raised, giving employees a more poignant sense of falling behind their retirement savings goal. Or something like that.Of course the increased limit would be a direct subsidy to those high-income employees who do currently and would under any contribution limit regime maximize their pretax contributions, paid for by employees who do not take advantage of or have access to pretax retirement savings vehicles.

The solution isn't a secret, you just won't personally like it

The most interesting thing about 401(k) plans is that you, if you participate in one, probably think they're the key to securing a dignified retirement in the 21st century. But you're wrong. There is no source of data which suggests people need or use 401(k) accounts in order to finance a dignified retirement.401(k) accounts are used by a small minority of wealthy individuals to shield income and capital gains from taxation during their lives in order to maximize the amount of wealth they leave to their heirs.Just as with the use of 529 college savings accounts for higher education expenses, you're allowed to use 401(k) plans for retirement savings, but that's not how they are actually used by wealthy families trying to shield as much income as possible from taxation.The solution is easy: eliminate preferences for employer-based retirement savings accounts. Increase individual retirement account contribution limits. Enforce strict quality and fiduciary standards on retirement account advisors.But you don't want the easy solution because you don't want a solution at all: you want to shield as much of your earned income and capital income from taxation as possible, to leave as much as possible to your heirs. So, at least for now, we muddle along.

On the dryness of powder

I sometimes come across a moderately sophisticated intuition, and find that while I don't strictly speaking agree or disagree with it, I do find it basically meaningless without additional context. This intuition says, "anything that can be done in an urgent situation can and should be done before the situation becomes urgent."So, for example, if you would need to tap your home's equity in order to pay for a medical bill of a certain amount, that's a sign that you don't have adequate cash available and you should take out the home equity line of credit now, before you have a medical emergency, rather than wait until you actually need the cash.When it comes to investing, people are often willing to accept a permanent drag on their portfolio in the form of less volatile short-term and intermediate-term bonds in order to preserve so-called "dry powder" should the equity markets tumble and put stocks on sale. The premise underlying this behavior is that people invest 100% of the income they have available to invest, and then they decide how to allocate that investable income according to their meticulously-calculated "risk tolerance" (or some other metric, like age or target retirement date).My sense is that people both have more financial resources at their disposal then they generally think, and that waiting to tap those resources until a promising investment opportunity arises makes perfectly good sense.

Sources of cheap liquidity

Many people have sources of cheap liquidity available they aren't aware of and spend no time thinking about:

• if you make more than the minimum payment on your student loans, you have excess liquidity;
• if you make more than the minimum payment on your mortgage, you have excess liquidity;
• if you replace your phone before it stops working, you have excess liquidity;
• if you buy food or drinks in restaurants instead of at retail merchants, you have excess liquidity;
• if you replace your wardrobe more often than necessary, you have excess liquidity;
• if you replace your car more often than necessary, you have excess liquidity;
• if you buy new cars instead of used cars, you have excess liquidity.

Now, unlike your average moralizing personal finance blogger, I don't see any virtue or sin in any of the above. I don't think debt is terrible and that you have to get rid of it as soon as humanly possible, and I don't think new cars are terrible and that you have some kind of moral obligation to never buy another one in your life.

Deciding when and where to deploy excess liquidity is hard, but everything is hard

My point is that spending behavior which may make sense in the low-expected-return investment environment we have today may not make sense in a future, high-expected-return investment environment. Today, accelerating payments towards loans in order to secure a modest but guaranteed investment return may make sense. After the next financial crisis those excess payments may be better used to load up on cheap equities. Today, eating out and networking with colleagues may offer a better return than the modest expected future gains of the stock market. Tomorrow, plowing that money into high-yield corporate bonds may offer a better prospective risk-adjusted return.If your project is to reach a million dollars, or two million dollars, or ten million dollars, in net worth before any of your friends, then sure, you should strip away all your excess expenses today and invest entirely in an aggressive-but-well-diversified portfolio of stocks. But life is more than a net worth statement, and spending more and investing less this late in a bull market makes perfect sense to me.

How you might be, but probably aren't, affected by the TIAA "scandal"

A little bit of knowledge is a dangerous thing, and last week the New York Times published a pearl-clutching article that contained a little bit of knowledge. They reported that a TIAA (formerly TIAA-CREF) insider had filed a whistleblower complaint alleging:

"that TIAA began conducting a fraudulent scheme in 2011 to convert 'unsuspecting retirement plan clients from low-fee, self-managed accounts to TIAA-CREF-managed accounts' that were more costly. Advisers were pushed to sell proprietary mutual funds to clients as well, the complaint says. The more complex a product, the more an employee earned selling it."

This is, obviously, not ideal behavior. But the Times article seems almost deliberately written to confuse investors about the behavior being alleged and its relevance to individual investors.

There is no allegation of wrongdoing in TIAA-CREF mutual funds or annuities

TIAA-CREF offers a range of mutual funds, including a social impact bond fund I've mentioned favorably in the past. There's no indication that any of those mutual funds were mismanaged in any way.TIAA also offers annuities. While annuities aren't for everyone, they are a good fit for some people, and I don't have anything against annuities in general for folks who want to pay up front to finance some or all of their retirement with a fixed or inflation-adjusted income stream (although I would generally urge against anything fancier than that). Just as above, there's no indication in the Times' reporting that TIAA annuities are being mismanaged or that annuitants are being taken advantage of in any way.

The wrongdoing is alleged against TIAA's advisory business

What is really being alleged, and what is really troublesome, is that TIAA advisors are being incentivized to move TIAA's captured investors (mainly public-sector employees) out of products which are best for the investor into products that are more profitable for TIAA. If true, that's unacceptable and will hopefully lead to fines and sanctions against TIAA. If false, well, hopefully the Times will run another article when the claims are disproven or dismissed.

It is difficult to get objective advice

All this may come across as nitpicking, but there are a few reasons I think it's important to take seriously the different kinds of claims that can be made against an investment manager or investment advisor.An investment manager can abuse the trust of their customers in a range of ways. Perhaps most notoriously, a fund that claims to be "actively managed" and charges correspondingly high fees can be a "closet indexer," in fact hugging an index that can be invested in for next to nothing. Likewise a mutual fund with a large cash holding and which charges a management fee on its entire portfolio, including cash, will be charging a disproportionately high management fee on its actual investment decisions.An investment advisor also can abuse clients' trust, for example by liquidating annuities, insurance policies, or real assets in order to "gather" assets under management, upon which the advisor will collect a fee or, as in the case of the allegations against TIAA, moving clients from low-cost self-managed accounts to high-cost TIAA-managed accounts.

If you're not paying for your investment advice, who is?

In the interests of avoiding legal action for as long as possible, let me make the broadest possible argument and let you judge it on its own merits.The responsibilities of mutual fund companies and insurance companies to their investors and annuitants are fairly clear in American law. A mutual fund can make bad investment decisions, and it can charge more than it deserves to charge, but it mostly can't run off with the money to play roulette in Monte Carlo. An insurance company can go bankrupt (ahem, AIG) but it can't simply decide not to pay annuitants their contracted payouts because it would prefer not to.The responsibility of the employees of banks and insurance companies to direct clients to the mutual fund, annuity, or other investment product in that client's best interest is much more unsettled in American law. And if you're not paying someone to provide you with unconflicted investment advice, it's not obvious that anyone is paying to provide you with unconflicted investment advice.That creates an opening for any company, and I mean any company, to provide you with conflicted investment advice instead. That's not unique to TIAA; there is a very large, very boring area of employment law addressing the question of whether companies have to select their 401(k) provider in their employees' best interests or if they only have to select the investment options within the 401(k) in their employees' best interests.

I'm not blaming victims, I'm trying to prevent victims

Obviously it's infuriating to read about someone who has worked hard as a public servant, saved their whole life, and played by the rules discovering that they've been hoodwinked into an unsuitable investment. I'm not trying to minimize that: if TIAA really gave conflicted advice to their captured customers, they oughta pay for it.But if you don't want to be the next sympathetic story in a New York Times article, it's up to you to identify those potential conflicts in advance and either make your own educated decisions or find an unconflicted advisor to assist you in making the decisions that are best for you, rather than for your 401(k) custodian.That's an annoying, burdensome responsibility. But if you aren't willing to take it upon yourself, you're likely to find someone else is willing to take it upon themselves to take advantage of you.

The Social Security magic trick

I often say I like writing about money because it's an area of human activity that naturally lends itself to my unfortunate literal tendency. Today's post is a good example of what I mean by that.

Everybody knows Social Security retirement benefits rise the longer you delay claiming them

Usually this is framed as an incentive to "delay retirement" or "keep working" past age 62. I've even written before about the effects of late-career Social Security contributions. But today I'm not interested in your career plans, I'm interested in your Social Security claiming strategy.While early retirement benefits are decreased on a month-by-month basis and late retirement benefits are increased on a month-by-month basis, let's dispense with that calculation and use just three values: claiming as soon as you're eligible at age 62, claiming at full retirement age (67 for workers born in 1960 or later), and claiming at age 70:

• at age 62, your benefit is 70% of your full retirement age benefit;
• at age 67, your benefit is 100% of your full retirement age benefit;
• at age 70, your benefit is 124% of your full retirement age benefit.

As an aside, no one uses these values because of the 30-year-old fad for panicking over the solvency of Social Security. But defending Social Security is a political choice, not a matter of accounting, so I am using the figures found in current law.There is one additional nuance that is not especially relevant for reasons that will become clear but I want to mention anyway for the sake of completeness. The dollar amount you will receive at age 70 is not 77% larger than the dollar amount you would have received at age 62, even though 124 is 77% larger than 70: the dollar amount you'll receive is substantially larger, since your "primary insurance amount" is adjusted for inflation in addition to being adjusted for delaying retirement. Note that this is not the wage-inflation adjustment that's applied to your earnings in order to calculate your primary insurance amount. It's a separate, consumer-price adjustment (technically "Consumer Price Index for Urban Wage Earners and Clerical Workers") applied to your primary insurance amount every year whether or not you are collecting a retirement benefit. If you want way, way too much information about this process see this Bogleheads thread.

Nothing up my sleeves

Ready to be dazzled? Let's say you plan to have no earned income beginning at age 62, and you need exactly $14,880 in annual income (mechanically scale this amount according to your own needs).This is, conveniently, your old age benefit if you delay claiming Social Security until age 70 if your primary insurance amount is exactly $1,000 (again, scale according to your own situation). Now, you have three options:

• Claim your old age benefit of $8,400 at age 62 and supplement it with $6,480 in income from your accumulated savings. Using a 4% "safe withdrawal rate," you'll need $162,000 in savings to comfortably retire.
• Claim your old age benefit of $12,000 at age 67 and supplement it with $2,880 in savings at a 4% safe withdrawal rate, which requires $72,000 in assets at age 67. However, you'll need to supply 5 years of risk-free, inflation-adjusted income between age 62 and age 67 (remember, you won't have any earned income after age 62). That will require $74,400 more housed in a nice inflation-adjusted vehicle like Vanguard's short-term TIPS fund, for total assets at age 62 of $146,400.
• Claim your old age benefit of $14,880 at age 70. You won't require any ongoing income supplement from your accumulated assets, but will need to cover $119,040 in expenses for the 8 years between age 62 and age 70.

The longer you wait to start claiming your old age benefit the less savings you need when you stop working.How's that for a magic trick?

Come to terms now with the fact that you will feel poorer in old age

Today we are enjoying the fruits of a politics founded, at its core, on the principle that the wealthiest, most powerful people in our society feel ill-used by the political system they exert an almost unfathomable amount of control over. They feel that someone, somewhere, must be pulling one over on them, whether it's immigrants, ethnic minorities, the poor, public school teachers, or climate scientists.Many people find this difficult to understand, or at least they pretend to. I don't find it difficult to understand at all. On the contrary, nothing could be more natural. What I would like to do today is give you a little pep talk, so that when you're a bit older, you might not feel the same impulse to sabotage our civilization out of generational grievance.

In 30 years the GDP of the United States will be much larger

Right now our political class is engaged in a posturing game over what rate of near-term growth we can squeeze out of our economy this late in the business cycle. In some ways, this is an extremely urgent agenda: higher economic growth rates, like all growth rates compounded over long periods, result in wildly different end values.In other ways, it's not worth thinking about at all: over 30 years a 1% real GDP growth rate will result in an economy 35% larger, 2% real GDP growth will give an economy 81% larger, and 3% real GDP growth will leave us with an economy 143% larger.The difference between the numbers is large, which is why growth rates matter, but none of the growth figures returns a real economy smaller than the one we have now, and indeed, there's no reason to believe the real economy will be smaller in 30 years than it is today.It will, in fact, be much larger.

In 30 years the economy of the United States will look radically different

I do not know what the economy will look like in 30 years, and anyone telling you they know what the economy will look like in 30 years is lying to you. The only thing you need to know about the economy of the United States in 30 years is that the number of workers per dollar of GDP will be much lower than it is today.That's a mechanical product of two functions: a much higher real GDP (see above) and a much lower number of workers as a share of the total population.It's almost irresistible, when you have two facts like these you know to be incontrovertibly true, to reach fantastic conclusions about driverless busses, libraries without librarians, grocery stores without cashiers, banks without tellers, factories without workers, and so on.But there's nothing inevitable about that. We could decide to pay bus drivers enough that we still have busses driven by humans in 30 years. We could pay grocery store cashiers and bank tellers so much that we still have humans performing those jobs in 30 years. We could keep factories open staffed with unionized workers. The only thing you need to know is that higher GDP and fewer workers will make every decision to use human power expensive and deliberate.

You will experience that economy and your role within it as a kind of immiseration

The good news is that you, personally, will be much wealthier in 30 years than you are today. You'll either be in your peak earning years, or collecting your wage-inflation-adjusted Social Security benefit and drawing down the vast fortune you've accumulated across IRA's, 401(k)'s, 403(b)'s, 529's, health savings accounts, and of course taxable accounts.The bad news is that you will be paying more for everything, and you'll experience those increased payments as a burden despite your increased wealth.Here are a few of an unlimited number of examples:

• If we maintain a service-oriented economy, wages will be much higher, and the cost of services will rise. Full service restaurants will become much more expensive. Gratuities will become mandatory "service charges," and you'll complain about how tipping used to be voluntary.
• Alternatively, if we end up automating as much of the economy as possible in order to keep down prices, you'll find annoying how hard it is to find someone to complain to when an item scans incorrectly at the grocery store.
• In the health care sector, if you're below the Medicare enrollment age you'll be paying more in insurance premiums (whether or not the ACA is repealed, plans are allowed to "age rate" premiums for older folks) and insurance premiums as a whole will be much higher simply through the operation of medical price inflation.
• Your state and local taxes will be higher in 30 years than they are today. You'll likely own your own home by then if you don't already, so you'll be paying property taxes directly instead of having them folded into your rent. Meanwhile, property values in the kind of well-functioning communities you'll be able to afford to live in will be much higher in 30 years. That means you'll be paying property taxes on a higher assessed amount.

The key point is that it doesn't matter exactly which economy we end up with in 30 years. You, personally, will experience that changed economy as an affront, because you'll be 30 years older, and you'll remember how things are now, and how they were when you were growing up, and you'll compare them to the (as-yet unknowable) conditions of 30 years from now.You, personally, at age 60, or 65, or 70, will have to deal with new and confusing technology that is not going to make you feel good. I think a lot of 30-year-olds understand the difficulty their parents have with today's technology, but don't have a glimmer of understanding of the trouble they're going to have with the technology of 2047.

Inoculate yourself against grievance

I wouldn't ask you to read all the way through this without offering some solutions. While there's nothing you can do to prevent yourself from feeling poorer in 30 years than you do today (despite your vastly higher wealth), there are some things you can do to avoid channeling that feeling into a politics of grievance and nostalgia.First, be conscious of the coming changes as they happen. At a McDonalds location near my apartment, they've installed an electronic ordering kiosk. You don't have to use it; you can still order at the counter. That's such a minor change it almost disappears into the background. But in 30 years, it's going to be all electronic ordering kiosks everywhere. Think about that, and how it'll make you feel, and you might not find it so jarring when that day comes.Second, support universal programs. In one of the only actual policy disagreements between Hillary Clinton and Bernie Sanders, Sanders argued that public universities should be tuition-free for everyone, while Clinton argued that they should only be tuition-free for the poor, middle class, and moderately wealthy, but not for the extremely wealthy (it was a weird campaign). Sanders was right: in my experience the wealthy treat the idea that the poor receive special treatment as a key source of grievance. The answer isn't to make life even harder for the poor: it's to eliminate the web of means-testing and income-verification designed to identify and exclude the wealthy from receiving benefits. If you have access to the same benefits as the poor in 30 years, you might not be tempted to accuse them of "gaming" the system.Third, engage your neighbors and community offline, outside of work. My impression is that people with kids have an easier time doing this because they have school events, extracurricular activities, and so on, but anyone can join a local sports league (bowling is easy, fencing is hard) or fraternal organization. This is good for your mental health in general, but it's particularly important as you get older to have a source of community that's not dependent on your workplace, or profession, or even your location. The more multigenerational, the better, since as you age you'll want to get gradually acclimated to the changes that are coming, rather than discover them all at once when Fox News runs a special report on kids these days.Finally, fight for an economy that works for everyone. Pick a subject you know a lot about, or nothing about, and get educated about it and educate others. I'm obsessed with entrepreneurs and entrepreneurship. Find a topic that excites you: zoning rules, public transportation, school funding, whatever. Show up at neighborhood or city council meetings. Vote! Staying engaged is the best way to fend off the sense of helplessness that might make you want to respond to fundraising mailers in old age.

Conclusion

As a millennial I'm obviously not thrilled with the way Baby Boomers have channeled their feelings of grievance and resentment into the politics we endure today. But the millennial generation is also the biggest generation since the Baby Boom, and it would pain me even more if, in 30 years, when we form the largest, most politically active demographic, we have turned our own grievances into a narrow, bitter politics directed against the young and the poor in a vain attempt to preserve our own sense of wealth and privilege.Let's do better this time.

What should you do if your Vanguard 403(b) account is getting access to Admiral shares?

Workplace 403(b) retirement plans are, very roughly speaking, the non-profit and public sector's answer to the 401(k) retirement plans offered by private companies. If your workplace 403(b) account is administered by Vanguard, you probably recently received a letter explaining some changes to your account. The most important changes are:

• a change in fee structure from a $15 annual fee per fund held in the account to a $60 annual fee regardless of the number of funds held;
• access to low-cost Admiral shares with no minimum investment requirement.

My understanding is the changes will go into effect in early November for plans affected by the change.

Why it matters

Previously, like 401(k) accounts held at Vanguard, 403(b) accounts only had access to higher-cost Investor shares. Combined with the per-fund fee, that meant many investors were best off investing in a single target retirement date fund or fixed-allocation LifeStrategy fund in order to pay as few per-fund fees as possible. Since those funds hold higher-cost Investor shares, they're a bit more expensive than a 3-fund or 4-fund portfolio built with Admiral shares or Vanguard ETF's, so many investors prefer to assemble lower-cost portfolios with those instruments in their personal accounts.That wasn't possible in 403(b) accounts until now.

Who wins?

There are two ways 403(b) participants might benefit from this change:

• People with balances below $50,000 who already held 4 or more funds with Admiral shares in their account by definition will save money after the changeover: they were paying $60 or more per year ($15 per fund) for higher-cost Investor shares. Now they'll pay a flat $60, plus save money by paying lower expense ratios on each fund they hold, as long as it has Admiral shares.
• Anyone who held funds with Admiral shares that are sufficiently cheaper to offset any increase in annual fees. For example, if your only holding is Vanguard High-Yield Corporate Fund Investor Shares (hopefully as part of a diversified portfolio) you're currently paying $15 plus a 0.23% expense ratio. Admiral shares have an expense ratio of 0.13%, so if your balance is over $45,000, you will pay less in combined annual fees and management fees after the changeover.

Who loses?

The biggest loser in this changeover is folks with over $50,000 held at Vanguard and who intend to remain in funds that do not offer lower-cost Admiral shares. Previously, having Flagship status with Vanguard waived their per-fund fee in 403(b) accounts, so folks with $50,000 or more in assets at Vanguard paid no annual fees no matter how many funds they held in their accounts.Now, they'll pay a flat $60 annual fee no matter how many funds they hold or how many assets they have with Vanguard. As explained above, folks who hold Admiral shares in their accounts will see an offsetting reduction in fund expense ratios. But target retirement date and LifeStrategy funds are popular as simple, one-and-done investment allocations, and neither kind of fund offers lower-cost Admiral shares. That means folks exclusively invested in those funds will be paying higher annual fees (unless they were invested in 4 different funds for some reason), but still won't benefit from access to Admiral shares.

How to play it

I've laid out all of the above because of my unfortunately literal tendency, and the fact that money is one of the fews things in life that benefits from being taken literally. I think there are basically two ways a 403(b) participant can react to these changes:

• Do nothing. Remember, the absolute maximum you'll be paying in additional annual fees is $45 per year, since you were already paying $15 per fund in your account. If you are holding funds that offer Admiral shares, you'll see your Investor shares automatically converted and you'll make back some of the additional fees in lower expense ratios. If you aren't holding funds that offer Admiral shares, you'll remain in your Investor shares and pay the higher annual fee without seeing any benefit. Obviously it doesn't feel great to pay an extra $45 above what you were paying before, but that still only works out to what, four and a half bananas a year?
• Convert from a loser to a winner. If you are currently holding target retirement date, LifeStrategy, or other funds that don't offer Admiral shares, you can convert your current holdings into an identical allocation to the individual funds, which do. So instead of $10,000 in a Lifestrategy Growth fund, you could move to $4,780 in Total Stock Market, $3,210 in Total International Stock, $1,410 in Total Bond Market, and $600 in Total International Bond, all of which offer Admiral shares. Then you'd also want to tell your 403(b) administrator to change your payroll contributions to reflect those ratios. Between once a year and once a quarter you'll also want to log on and rebalance your account to reflect changes in the market value of those securities (I don't see any benefit to rebalancing more often than quarterly. Don't peek).

Finally, if you have other investments outside your workplace 403(b), you may benefit by being able to use Admiral shares to create a more appropriate overall asset allocation than you currently have. For example, if you previously held LifeStrategy or target retirement date funds in your 403(b), you may have struggled to appropriately allocate risk in your IRA's and taxable accounts taking into account that fixed asset allocation.Now, by holding the underlying securities, you can more finely tune your asset allocation across all your accounts. Of course, whether or not you actually benefit depends on how much time you want to spend micromanaging your investments!

I am rabidly in favor of tax simplification, which is why I oppose "tax reform"

Having failed to strip health insurance from tens of millions of low-income Americans, the Republican Congress has moved on to their next project of radically reducing the taxes paid by a sliver of high-income Americans. If you follow this debate over the course of the next few months, you'll hear a lot about the distributional consequences of their plan. The top tax rate will be lowered, the bottom tax rate will be raised, and they'll briefly talk about eliminating some deductions until the lobbyists arrive and "convince" them otherwise.I think our tax code needs to be radically simplified, but I don't have any interest in lowering rates, reducing the number of tax brackets, "broadening the base," or any of the other talking points Republicans will use during this debate.I think our tax code needs to be radically simplified because its complexity imposes a psychic tax on every American, plus a financial levy on people who find themselves paying tax preparation firms because they're unable to navigate the tax code's complexity on their own.

Eliminate itemized deductions

Itemized deductions have one small problem and one big problem.The small problem is they've only claimed by high-income taxpayers, who pay enough in mortgage interest, state and local taxes, and charitable contributions in order to be eligible to claim them.The big problem is that the ability to deduct these and other items means even middle-income taxpayers are forced to think about them, gather receipts, store documents, and fret about being audited for each itemized expense.This is the psychic toll of itemized deductions people treat as so natural they forget they're paying it.

Equalize treatment of labor and capital income

The preferential treatment of qualified dividends and long-term capital gains have one small problem and one big problem.The small problem is that the ownership of capital is held disproportionately by the extremely wealthy, who do not need preferential tax treatment for their capital income.The big problem is that the preferential treatment of capital income induces the owners of capital to go to preposterous lengths to secure preferential treatment of their income.For example, the co-called "carried interest loophole" doesn't have anything to do with carried interest. It should properly be called the "capital gains loophole," since it's exclusively a function of the preferential treatment of capital gains. If capital income were treated the same as labor income, there would be no carried interest loophole.

Don't create an additional parallel income tax system for passthrough income

The single worst idea in the Republican "tax reform" plan is to create a third, parallel system of income taxation for passthrough income, the kind of income earned by sole proprietorships and S corporations. Today, your passthrough income is combined with your other earned income and taxed according to the tax tables found in the IRS Form 1040 instructions.That means under their proposal a person who has earned income, capital income, and passthrough income will have to calculate three different components of their income tax. Already today people have to calculate their earned income, short term capital gains (taxed at ordinary income tax rates), and long term capital gains (taxed at preferential rates).Under the Republican "tax reform" proposal, they'll also have to calculate an additional income tax based on their passthrough income.

I truly do not care what you do with the money

Eliminating itemized deductions and taxing capital income at the same rate as labor income would raise a phenomenal amount of money. My weak preference is for the federal government simply to keep the increased revenue and increase the budgetary headroom available to deal with the coming economic calamities.Alternately, you could cut marginal income tax rates. How and where to cut marginal income tax rates would surely be a lively source of debate on Capitol Hill.Or you could chop up the increased revenue and turn it into a guaranteed basic income for all Americans.The point is that it doesn't matter what you do with the money, because simplifying the tax code is an unalloyed good.The small problem with the Republican tax plan is that it's designed to funnel enormous amounts of money towards the wealthiest Americans.The big problem with the Republican tax plan is that it doesn't do a thing to simplify the tax code.

Why I do my own taxes (and why you might not)

Every year around February 1, I fire up the IRS's Free File Fillable Forms and begin the arduous process of manually inputting all my income and expenses for the year. I have what you could think of as either a very complex individual tax return or a very simple business tax return.It's a very complex individual tax return since I have to fill out Schedules C and SE in order to report the income from my sole proprietorship, while most employees just have to copy the information from the W-2 their employer provides. Alternately, it's a very simple business tax return since I don't have any depreciation, cost of goods sold, inventory, etc. I have my income and my expenses, and essentially all I have to do is deduct the latter from the former.Due to my low income I'm eligible for free commercial tax filing software from the IRS, but I have used the public FFFF for the past 4 years of tax preparation.

"Interview-based" tax preparation software drives me nuts

Every commercial tax preparation software I've used has the same model for tax return preparation: you're asked a series of sequential questions covering every imaginable situation the tax code covers. For example, you'll be asked a seemingly harmless question like, "did you move during the tax year?" If you answer "yes," you'll then be subjected to another hundred questions about your moving expenses, how far you moved, how soon after moving you started your new job, how the weather was during your move, etc.My problem with this system is that it treats the answers to the questions as constants, when in fact they're variables. "How much money did you contribute to an IRA this year?" is not a constant — you can contribute money to an IRA up until your tax filing deadline, well into the next calendar year. That means the system's outputs, like adjusted gross income, are also variables. Whether you qualify for a retirement savings contribution credit, and how much it works out to, depends on your AGI. But your AGI depends on how much you contribute to qualified retirement plans! By treating these variables as constants, tax software in my experience is actively harmful for folks trying to minimize their tax bill. It offers a faux static precision for a process that is better understood as dynamic.

Free File Fillable Forms is not perfect

I personally like the IRS's Free File Fillable Forms since it lets you fiddle with individual variables and then recalculate the resulting values (they call this function "do the math" because they think they're cute). You're given the option of adding virtually any of the common IRS forms to your return, inputting the values you have control over, then allowing FFFF to do all the worksheet calculations in the background, and populate your 1040 with the final values.One problem I have run into occasionally is that while forms populate their values to the 1040, it doesn't always work in reverse. For example, Form 8880 (Credit for Qualified Retirement Savings Contributions) will properly populate line 51 of Form 1040, but it takes as one input your AGI from line 38 of Form 1040, and that has to be manually inputted.That sounds like a quibble, but if you don't know about it and you do something elsewhere on Form 1040 to change your AGI (e.g. increase contributions to an IRA or other pre-tax retirement account), you have to remember to go back into Form 8880 to manually adjust it, for example if you're trying to get your AGI below the highest-credit threshold of $18,500.

For most people in most years free commercial tax software is probably fine

Most employed folks who receive exclusively W-2 income, participate in a retirement savings plan at work, have an IRA, and might be making student loan payments are probably well-served by free commercial tax software. The earned income and retirement savings contribution credits phase out fairly quickly, so moderate-income people are unlikely to be able to claim them (unless they have a lot of kids, in the case of the earned income credit), and the standard deduction is high enough that moderate-income people are also unlikely to benefit from itemizing deductions for things like state and local taxes and charitable contributions.

Tax complexity is a payoff to the tax preparation industry

Of course, that begs the question: since most people's tax returns are so simple they require nothing more than your W-2, your IRA contribution, and the number of people in your household, what's the point of the rest of the lines? The point is to create a tax system so complex that people feel compelled to resort to commercial tax preparers in order to avoid the risk of audits and penalties, and to create a generalized animosity towards the payment of taxes in general. Don't believe me? Here's Grover Norquist of Americans for Tax Reform on tax simplification:

"This system will gradually be expanded to more and more taxpayers, and will eventually become mandatory. Income tax filing will be like getting a real property tax statement in the mail—it will become little more than paying a bill."

To be clear, he means this as criticism, not the praise it's rightly understood as.

Conclusion

It's possible to hold two ideas in your head at once:

• Tax preparation is something that needs to be taken seriously and done well, especially for the self-employed and those seeking to retire early. Knowing about and maximizing the value of retirement contributions, identifying potential deductions, harvesting capital losses and gains, and rolling over pre-tax and post-tax accounts as appropriate are all appropriate strategies for saving money given the tax code as it currently exists.
• The tax code as it currently exists is deeply broken not because it incentivizes the wrong sorts of activity, but because the fact that it contains incentives for this kind of behavior at all makes tax planning occupy a disproportionate and unnecessary share of the cognitive real estate of people who could otherwise spend their time doing literally anything else.

In other words, the problem with the mortgage interest deduction is not that it drives up real estate prices and costs the US Treasury $70 billion a year. The problem is that it makes people think about the mortgage interest deduction. Eliminating the deduction and giving all the money back to taxpayers through lower rates wouldn't just be a good idea for eliminating a distortion in the housing market; it would be a good idea so no one ever had to think about the mortgage interest deduction again.Likewise the earned income credit has received a lot of praise, both deserved and totally undeserved, for reducing poverty among low-income workers. But it also requires a 38-page booklet of instructions for properly claiming it, primarily because of its elaborate phase-in and phase-out rules, definition of "earned" income, limits on investment income, etc. Even if you think a refundable tax credit for low-income workers is a good idea, why phase it out or place any limits on it at all? Why not simply reclaim the value of the credit through higher rates on higher-income workers, creating a kind of negative income tax for low-income workers at no net cost to the Treasury?At the end of the day, you shouldn't support tax simplification because your personal finances will suffer or be improved by it. You should support tax simplification because you deserve better than to build your life around optimizing your tax situation every year.