Personal Finance

Dispelling myths and affirming realities- when to invest in a 401k


Main takeaways

When you take these myths and realities together, you’ll see that unless you have an employee match on your 401k, you may be better off exploring alternative retirement accounts such as IRAs and Roth IRAs because they also shield you from capital gains taxes. And despite common misperceptions, there are ways to invest in non-401k retirement accounts regardless of your income level. If you have a match, you might put every penny up to it that you are able, but not a single penny more. And if it’s available, you might use a broker-linked account that enables you to invest in a market-tracking vehicle and avoid wasting money on management fees. Alternatives will be discussed in coming posts.

Did you know? 401k refers to section 401(k) of a 1978 piece of legislation that spawned the growth of the mutual fund industry.

Myth #1 versus Reality #1: Tax-advantaged compounding is a myth, but there are capital gains benefits

Myth #1: By putting my pre-tax dollars to work in a 401k, I am putting my money to work earlier and letting it compound so I have more in retirement.

Busting myth #1: This is a very common misconception, and I’m shocked sometimes at how many sophisticated people fall into this trap. Putting your money aside in pre-tax dollar form does not enable you to tax-free compound and end at a higher amount. Let’s illustrate with an example:

Scenario where you put pre-tax money aside:

Suppose you put $100 away pre-tax into a retirement account. Over time, it doubles. So you now have $200. When you go to withdraw these funds, you will have to pay taxes. Let’s say your tax rate is 30%, then you will have $140 net dollars (taking 30% off $200).

Scenario where you put post-tax money aside:

Suppose you take that $100 from your paycheck and pay your taxes now ($30 at 30% tax rate). Then you have $70 to invest. Over time, again, it doubles. You now have $140. This is exactly the same amount you have in the pre-tax example above.

There is no such thing as pre-tax compounding. Conceptually, in the end, your money, including accrued gains, will be taxed, putting you into the same situation. Mathematically, you’re just distributing the tax rate (if static) to a later part in the equation. There are arguments, such as a view that your own personal tax rate will fall, but that is beyond the scope of this post and a future subject. Also note, I did not incorporate capital gains taxes for simplicity in the above, but they would not change the conclusion if static. Main thing I want to dispel is the notion that there is such a thing as a pre-tax compounding advantage.


Reality #1: There are still tax savings in the form of capital gains shields utilizing retirement accounts.

You will pay income tax, one way or the other (pre-tax or post-tax), when investing in retirement account. But there is another tax to worry about – the capital gains tax. And that is one benefit of most retirement accounts, including 401k’s. Capital gains taxes are “extra” taxes you incur on any gains on investments. Shielded retirement accounts (401’ks, 529 accounts, IRAs, Roth IRAs) avoid those gains. In contrast, if your money is not in a shielded retirement account, you will pay those gains. Here’s an illustration:

Scenario where you invest in an account without a tax shield

So let’s say you put $100 after income taxes (money from your take-home pay) in an account (not a tax-shielded retirement account but a regular old account). Suppose it doubles to $200, then you have a capital gain of $100. That $100 is subject to the $100 capital gains tax. It depends on your income level, but for most people this is going to be around 15%. That means, you have to pay $15 in capital gains taxes. So, in the end, you’ll have $185.

Scenario where you invest in a retirement account with a tax shield

Let’s say you put the after-tax $100 in a tax-shielded retirement account. Suppose it doubles to $200. You then have $200 as the gains are not subject to capital gains taxes.


Myth #2 versus Reality #2: Access to superior investments is a myth; higher fees is a reality

Myth #2: With my 401k, I am investing in a professional who will manage my money better than I could or a passive investment could.

Busting myth #2: It has been widely established that mutual funds may chronically underperform the broader market, even on a risk-adjusted basis. Here’s one example from UPenn discussing this topic. Over the past 15 years, for example, the average mutual fund has returned about 6% on average versus about 9% for the S&P 500. That’s 3 percentage-points lower per year. That means if you put in a dollar at the beginning of the 15 year period, you’d have $3.64 if you invested in the market versus $2.40 if invested in the average mutual fund. And that doesn’t even include excessive fees from mutual funds that would drop this to about $2.15. It’s not really about finding the “right” manager; most underperform the market and charge excessive fees.

Data from S&P Dow Jones Indices

Reality #2: Investing in a mutual fund product costs you more in fees than alternative investments

Mutual funds (those who manage your 401k) can charge you up to 3% for a product that tends not to outperform the market. On average, they charge you 0.82% per year and may deliver subpar performance. 0.82% may seem like a reasonable or small fee, but it adds up. For example, if you put aside $1,000 every year for the next 30 years, and your investments went up 7% per year, you’d have almost $100,000 if you parked your money in a low-cost ETF alternative. However, you’d only have $87,500 if you invested in a 401k. Their fees would add up to over $14,000! If you are investing in a 401k, you might see if your plan has a brokerage link option, which enables you to freely invest in lower cost market-tracking alternatives without paying excessive fees.

Myth #3 versus Reality #3: Need to invest in 401k because over income limit for other products is a myth, but there is a valuable benefit from employer matching

Myth #3: I need to put my money in a 401k because I am over the qualified income limit.

Busting myth #3:

The income limit for contributing with deductions to an IRA ($103,000 adjusted gross income for married/joint or $64,000 for single). However, there is nothing stopping your from making a non-deductible contribution to your IRA and rolling those funds into a Roth IRA (like an IRA but taxes paid upfront). For example, suppose you make $200,000. You put $6,000 into an IRA. Now, you likely can’t just leave it there because you’ll be paying income taxes on any gains that come of it, and you likely still want to take advantage of the capital gains shield (discussed in Reality #1).

So you take that $6,000; you “roll” it into a Roth IRA. You will owe the income taxes on that amount (which is fine, you would have paid them if not investing in a retirement account anyways). Let’s say you have a 30% tax rate, then you have $4,200 for your Roth IRA. Any growth in the investments when you retire will not be taxed further. This is known as a “backdoor Roth IRA.”

We already established when busting Myth #1 that there is no real income tax savings from an IRA (it’s only the capital gains savings in Reality #1).

You’re actually free to contribute to your IRA no matter what your income level is. You’ll just pay the taxes upfront. So unless you have a view that taxes will fall from present rates, which realistically is anyone’s guess, you might go ahead and just fund your IRA and roll it into a Roth IRA. The standard limit is $6,000 ($7,000 if you’re age 50 or older), but there is such a thing as a mega backdoor IRA that enables you to put away $56,000 per year in total between your 401k and Roth IRA. That will be the subject of another post. There are also alternatives, such as 529 accounts, which I would suggest only investing in if you are putting away more than $56,000 because they do not offer real benefits beyond that of an IRA (which can be used for education expenses). Subject of a future post as well.

Reality #3: Only real reason to not use alternatives is employer matching The primary reason to invest in a 401k is employer matching. To the extent your employer provides matching, you likely can’t really beat that option. It’s essentially “free” money (technically it’s not free because without this retirement benefit your pay would likely be higher, but it is what it is). It’s true your mutual fund may underperform the market and charge excessive fees, but you can’t beat free money. Let’s say your employer matches up to $6,000 and you take advantage of that option. You would basically need your 401k to fall and the market to rise in order to lose. As subpar as returns for mutual funds can be, that would be pretty atrocious investing and not likely something you’ll experience. So the bottom line is if you have a match option, you should take advantage of it; it trumps all other points. But you should likely not put a single penny in above your match amount.


Hope you enjoyed the post, which is the first in a series of retirement planning posts. If you have a topic you’d like me to add to the pipeline, please suggest in the comments below.

Did you know? Japan adopted the 401k system and refers to it as a 401k even though there is no section 401(k) in Japanese legislation.

Blurbs Themes

The market is a feckless child and school is out

I’m introducing the short blurb with this blog post.

Many people are under the impression that the rapid recovery in the market is an indication that things are fine and will be fine, and they missed an opportunity to buy a dip. Here’s a sample of someone presenting that view.

I’d disagree with this for three main reasons:

(1) Anyone looking to the market for confirmation is doing it backwards. In my early days as an investor, I thought the market was the ultimate barometer of truth and viewed it as “right” no matter what; I thought that if one were on the wrong side of a stock (or market broadly), one needs to take a lesson from the market and understand where they are wrong. Experience has taught me this is just dead wrong. The market (and stocks) are prone to tantrums and irrational thought. Be a parent, have some conviction that you know what is right and don’t take your lessons from a child.

(2) We have seen an unprecedented recovery in the financial markets in the past three weeks, far faster than normal. For reference, it took 231 trading days for the market to recover 25% off the trough levels in the 2008-2009 crisis. In 2020, it’s taken 23 days. It took 327 days to recover 50% in 2008-2009. In 2020, it’s taken 38 days. That’s just very fast, arguably too soon, with an economy that is set to see a 40% decline in GDP. Just look around you – everything is shuttered, and as I noted in my post, “Why I dumped all my holdings…”, the consumer is 70% of the economy and most of its growth; that engine is clearly in full fail mode, it is not going to turn around anytime soon (regardless of a turn in the second derivative of Covid-19 death rates), and all datapoints from here on out may deteriorate (or show transitory improvement then deteriorate) (just look at today’s retail sales, industrial production, etc.).

(3) The massive recovery in a short window, when we may not have even seen the true trough, reminds me of a feckless child erroneously applying faulty logic, often from prior examples. But the present situation is not similar to the past; it is its own animal. If you’re taking your cue from the market that the economy will just turn back on immediately, first note that the VIX (volatility index) is at 40%; we’re bound to see wild (silly) swings in the market. Second and most importantly, look at school closings as a barometer. The vast majority will not open until September. Think about how much revolves around that. I don’t believe you see the switches turn back on until school is open.

S&P 500. Underlying data from Bloomberg.
VIX index is above Financial Crisis levels; you should see moody swings.
Conference calls Stocks

American Airlines and their Black Swan Moment: What they said and what they did

 Quick version of American Airlines’ commentary

“…people would suggest we should be less levered, that is, in the risk of something, for risk protection…” American Airlines CEO – 2Q2018 earnings call

Airlines have received a good deal of attention lately related to their potential bailouts, with some critics noting they have aggressively been buying back shares rather than accelerating debt paydowns and shoring up cash for any unforeseen circumstances. Many airlines have repeatedly gone bankrupt over the years. Since the end of 2013, they have spent 96% of free cash flow on buybacks. American Airlines, in particular, repurchased almost $13 billion of stock. Bloomberg, The New York Times, The Wall Street Journal, Forbes, and Dallas Morning Times (AAL is based in Dallas), have all written about this.

I’ve taken a different approach in this blog post, by assembling American Airlines’ own commentary on debt and buybacks over the past couple of years to see if they were aware of the risks and what they said about it.

I want people to form their own conclusions, so please check out the above video summarizing their comments.

It’s a trimmed down video. For those who want to dig deeper, I’ve also assembled the longer video below with more complete comments.

And for those who would like to dig even deeper, further below are links to the actual full transcripts for totally complete comments.

Add your opinion on the subject to the comments below.

The longer video

Long version of American Airlines’ commentary
From public filings.


1Q2018 (4/26/2018)

2Q2018 (7/26/2018)

3Q2018 (10/25/2018)

4Q2018 (1/24/2019)

1Q2019 (4/26/2019)

2Q2019 (7/25/2019)

3Q2019 (10/24/2019)

4Q2019 (1/23/2020)


Fun Personal Finance Stocks Themes

Toilet Paper Economics: You can now stop buying TP and may want to stop buying TP stocks

The Toilet Paper Curve

Uses Nielsen weekly TP sales data and Statista data on per capita consumption.

The empty shelves and scarcity of toilet paper (TP) we are witnessing are not frenzied consumer buying, but rational behavior. It’s not obvious, but we consume a lot of toilet paper when we’re at the office/jobsite (where we spend a lot of our day). With quarantines in place, this means you use more toilet paper at home – 40% more, in fact, per Georgia Pacific (large TP producer). Thanks to Will Oremus at Medium for cluing us in on this.

So, a key driver of the surge in pandemic-buying is we all began to overnight basically consume 40% more TP. The second driver is that Americans typically hold about 2 weeks of TP inventory at home (so you don’t have to run out and buy the bulky packages or have them delivered so frequently). Recent trends suggest with the uncertainty/desire to leave the house less, people are targeting about 4 weeks of supply. This seems like rational behavior.

How does the data stack up? When we model actual TP demand in the recent period and compare it to what we should see if people are consuming 40% more TP and seeking to expand their in-home inventories to 4 weeks from 2 weeks, it seems like the American consumer has done a fantastic job. So good job everyone.

When does it stop? Right now, we estimate the average person is sitting on 3.85 weeks of supply (assuming the increased consumption rate) versus the targeted 4 weeks – pretty darn close. Now, retailers’ inventory is depleted, and it takes time to convert the commercial production lines at TP plants to domestic use (office TP comes in giant rolls and are thinner). Given this constraint and assuming quarantines remain in place, we model that TP in-home inventory will dip to ~3.3 weeks in May-2020 from 3.85 weeks currently as we wait for this converted capacity to come online, then gradually rise to 4 weeks in July-2020. Importantly, the TP curve above assumes the quarantines remain in effect all year; if they end, consumers shift back to consuming some TP in office and lowering inventories, and we’ll see a decline in purchases sooner.

So, we’re close, but people will look to replenish their inventory, and it’ll take some time to get to a full average 4 weeks of in-home inventory. But you’re not going to run out.

Which countries use the most TP and which have sold the most recently

Americans consume more TP per person than any other nationality

TP-usage is correlated with how developed is a country, so it’s not surprising that we see the U.S., Germany, U.K., and Japan at the top of the list. But what is surprising is French people use half the amount of TP as Americans. This could be because of bidets. If you want to learn more (I don’t), here’s a BBC article on the topic.

Data from Statista.

Italy has seen the largest increase in TP purchases

Not surprisingly, countries hit hardest by the pandemic have seen the largest increases in toilet paper purchases, especially highly developed countries where the consumer may be more financially able to stockpile. What is surprising, however, is the French have stockpiled the least despite quarantines in place. Maybe since the bidet is infinite capacity, they don’t need to? Again, check out the BBC article, and maybe add a comment below explaining it (but I don’t really want to know).

Data from Statista.

A brief history of TP

For those interested in the 1973 Great Toilet Paper Scare, here’s an archived New York Times article on the topic…because history is important.

Key items from a passionate Orlando local reporter.

May want to stop buying TP stocks (WMT, PG, KMB) just for TP exposure

People react to crises in different ways. I have made the decision to exit the market entirely as I view this as such a shock to the system that conventional wisdom is out the window. Here’s my post on that.

Others have sought to strategically profit from stocks, including TP stocks, which may benefit from the crisis. I have no moral problem with that whatsoever, but I think it’s mistaken: First, the shortage is largely over – people have already built inventory; it’s prudent to get in front of news, not follow on after; we already have March-2020 Same Store comps data. Second, it’s not clear they even benefit (they may even be harmed) TGT and DLTR both had negative March-2020 sales reports despite the stockpiling as their discretionary, higher margin products are not moving off the shelves (people are buying essentials like TP and holding off on other purchases). One could argue that WMT is less discretionary than TGT, or that it’s better to own upstream TP producers like PG and KMB, but I believe this is trumped by the fact that overall TP consumption is not changing; maybe it’s front-loaded to last quarter and this quarter, but it will not change annual sales, and we’re already hearing companies talk about the costs associated with converting manufacturing and expediting shipments are rising; balanced against this is they are reducing SKU’s and mass producing essentials (which can lead to efficiency gains) and in some places, they are the only ones still open for business (e.g. more market share).

Overall, I think it’s too obvious a trade, we’ve passed the stockpiling window, annual consumption is unchanged, the stocks have already risen (outperforming the XLP staples group), and the cost side of the equation is far from clear. Now, if you want to own these stocks as a hiding place given strong balance sheets and a semi-defensive staples sector or if you know them really well and have reasons to own them, go ahead by all means (though I’d be curious why them and not the XLP), but you may want to stop buying them for just TP and wipe the stocks slate clean, lest you feel the burn (intended as a possibly inappropriate pun).

Data from Bloomberg; stocks indexed to 100 at start of year.

On a more serious note…

There are some who did not have the ability to stockpile TP; we’re talking averages here. If you want to help those less fortunate source some TP, check out

And that’s a wrap.


Follow-ups to why I dumped all my holdings

Data from Bloomberg.

Thanks to everyone for the encouraging and thoughtful feedback on the first blog post.

Two quick follow-ups based on questions I received:

1. How much would I have made since 2000 if I actually avoided the worst months in the market? This is a great question, and I put together the below exhibit showing the adjusted returns. If you avoided the worst month, you’d be up 208% instead of 156%, avoided the worst 2 months, up 257%…

Data from Bloomberg.

It made me think a bit more and raises an interesting point – maybe I’m not good at perfectly timing the market, but I know there is volatility in either direction ahead. It could be good or bad. What if I just removed the extreme moves (both good and bad), how would I do then? For this window where we kill the biggest months by absolute move, you’d have done actually better than just sitting in. Again, caution is warranted because we don’t always know when those periods will be and there could be false positives, but the current climate seems fairly certain for vol.

Data from Bloomberg.

2. What role does oil play exactly in this crisis? Oil’s sharp downward move (and likely looking to open down heavily on the lack of a Saudi-Russia deal) may be exogenous to the coronavirus and quarantine-related economic impacts, but it nevertheless serves as a knock-on trigger given that a substantial portion of the US industrial economy is indirectly linked to the oil industry. It’s true that oil and broader economic indicators and assets may just be correlated, but that correlation is rising, and during 2015, we heard from basically every industrials company on their 2Q/3Q calls of the derivative impacts oil was having on their business. Either way, it’s not encouraging for being in the market with this main barometer and/or driver sharply declining.

Data from Bloomberg.


Why I dumped all my holdings despite believing in “stocks for the long run”

Simple log extrapolation to 2020-end based on experts’ forecasts; for illustrative purposes – could be S-shaped and plateau sooner, but still a curve to mount. 2020-end forecasts from University of Massachusetts Amherst survey results.


I’ve been getting a lot of questions from investor buddies, friends and family about whether they should stick to their stock holdings with the current market turbulence or reduce them and wait for a better entry point. Historically, I advise people to not fool around and am an advocate of stocks for the long run. However, I’m “violating” my own principles in light of the present unique situation. These are special times.

What is the stocks for the long run philosophy?

The logic goes a bit like this: No one can perfectly time a market, but if they hold their money in the stock market, over time, since they are investing in continued economic and financial growth, they will be compensated for the inherent risk. The key qualifier being “over time.” And, coupled with this philosophy, is a view that one cannot “time the market.” Below is a compelling illustration showing that if you held the S&P 500 (or some ETF proxy) from 2000 to present, you’d have made 156% in total return space. However, suppose you tried to get “cute” and trade around; if you happened to miss the top 15 days in the market, you’d be down 10%. Point being, unless you have amazing insights that tell you precisely when to get in and out, you’re better off just sticking to it.

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Why might stocks for the long run be wrong?

While we have data back to the 1800’s on stocks, and stocks for the long run is viewed as conventional wisdom, this market may be different from history for two primary reasons:

(1) The market is highly concentrated with technology/healthcare accounting for almost half the market. The S&P 500 is a cap-weighted index and evolves over time. With the rise of FANMAG (Facebook, Amazon, Netflix, Microsoft and Alphabet), the market is almost 50% technology/healthcare. Lately, gains have been driven by multiple expansion rather than earnings growth, and we can see that growth stocks have dramatically outperformed value stocks for many years, which when the trend reverses, can be powerful.

(2) For almost a century, the economy has benefited from a “Great Moderation” of smoother, longer cycles, with industrial production volatility falling. With an unprecedented shock to the global economy driven by the coronavirus pandemic, the assumption of continued low volatility seems questionable.

In short, this is not your grandpappy’s market; you’re likely implicility betting on FANMAG and for the world as we knew it to continue.

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Where are we?

Let’s drill into two main drivers of the market and economy: oil and the consumer.

(1) The market’s correlation to oil has risen to almost 75%; pick any stock and plot it versus oil over time, and you’ll see the relationship getting tighter. At core, the US economy has become net long oil, not only from a direct production perspective, but from indirect effects on the industrial sector. This is why, for example, in 2015, we had an “industrial recession” when oil fell to the $40’s/bbl, with ISM moving into contraction territory (below 50).

(2) The “industrial recession” did not impact the broader economy and growth because of the consumer, which has long been a US strength that presently accounts for almost 70% of GDP.

With oil having fallen dramatically in the past month and coronavirus and related quarantines leading to a spike in jobless claims, there is an unprecedented consumer shock underway. The twin oil shock and consumer shock are likely not yet reflected in ISM and consumer confidence data. Does it seem prudent to step in front of that?

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Where are you and what are you betting on?

While the stocks for the long run philosophy is sound, let’s acknowledge that implementing that strategy still involves a bet…an increasingly popular bet, which makes it less attractive. And concretely, maintaining this strategy in the face of a shock never witnessed before in the historical analysis, implicitly means you’re looking through coronavirus and its implications, especially since we have not even climbed the death curve.

And that may be a fine strategy, provided you truly have the horizon. But I suspect many investors take the conventional wisdom of stocks for the long run and apply it even when they don’t have the staying power to hold over a 30 year window (life happens, withdrawals happen). That’s likely one driver of why investors underperform the market over time; they don’t fully and truly implement buy and hold. They “cry uncle” when retirement comes and they need income or beforehand.

So take stock of your retirement situation; ask yourself if you can truly withstand a possibly 15-30 year window where you don’t recover your losses (because those windows do exist in the historical analysis). If you can, you’ve likely positioned yourself well. But if you can’t, then you’re really not implementing stocks for the long run anyways. There’s a calculator below to help with this.

I’m not staying out of the market forever. I’m not sure if this actually “violates” stocks for the long run. When I backtest sitting out a few months, the strategy still works…so long as you don’t make a habit of it.

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What’s next and when to get back in

I don’t take this decision to violate my personal investment strategy lightly, and this may not be the solution for everyone. Maybe you have enough if the market falls to still retire comfortably, but if you’re banking on it, I’d take stock…because this is not your grandpappy’s market.

In future: I’ll provide some guideposts I’m looking at for reentry. Hint: A turn in the second derivative of coronavirus deaths in the US.