PHILADELPHIA REFLECTIONS
Musings of a Philadelphia Physician who has served the community for six decades

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Why Bother Investing?
In a sense, money is worthless until you spend it.

Designated Lifetime Funds

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Social Security

Except for Social Security, most retirement funds are not required to be tax-sheltered ("Federally Qualified"), but one would be foolish not to take advantage of the option where possible. Ordinarily, just about every other form of saving must first net out federal taxes. The debts of state governments ("municipal bonds") are free of federal but not state taxes, but reflect that benefit by paying a lower interest rate; any overall advantage must be calculated individually, and quite often it is non-existent. Mandatory taxable income, more-or-less mandatory tax-exempt income, and optional; that's your choice, except for the decision to put them in a federally qualified pension fund. Most people just throw the ownership certificates into a safe-deposit box and forget them. This article suggests you create three funds, whether in a lock-box or brokerage account, and mentally rename them by overall purpose. There's not much you can do about tax status, but you have a little latitude about how and when you spend the the money. It can make a certain amount of difference, because increasingly it is true that investment performance is affected by taxes and fees. Friends, neighbors and classmates may tell dazzling stories about astonishing investment luck, but if you want to have the best performance in your social circle over the very long haul, you would be well advised to focus on taxes, transaction costs and fees. Especially fees.

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Saving Bonds

When Grandpa gives a brand-new grandchild a hundred dollars, it can be spent on a new rattle or it can be invested. Rattles usually win, but occasionally it gets invested; what it's worth when the newborn finally dies will mostly depend on two things: how old he is when he dies, and how young he was when he started the investment. To make it easy to calculate, let's assume a life expectancy of 85 years, and an interest rate of 7%; that seems to imply a value of $40,000 at the time of death. That seems to imply a value of zero if he dies without spending any of it, and a value somewhere around $30,000 if he pays current income taxes. But if he pays $100 a year for the lock-box, he will only have $20,000 left after expenses. And if he pays fees for his checking account, or receives only nominal interest for a savings account, he may end up with nothing at all. Since that's the usual outcome of most cases of Grandfather gifts, perhaps the choice of a rattle isn't so reprehensible. The whole investment process is too expensive to bother with, until the sum involved is several thousand dollars. At fifty times the hundred dollar gift we started with, the investment is $5000, and its final result is a retirement fund of two million dollars. Yes, the arithmetic can be argued with, and yes, lots of things can go wrong in 85 years. Maybe a one-million dollar benefit is more likely, but no one can dispute that it's a pretty easy way to die a millionaire instead of a pauper.

All right, that's your Contingency Fund. It's taxable, but almost everyone can start it pretty young and forget about it for long periods of time.

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Tax Fund

The Tax Exempt Fund gets created when you start to work, even for a few days as a teen-ager. Several percent of your earnings will be withheld for the Social Security program, which requires that you apply for a Social Security number. If you wish, you can start depositing up to a set limit of your earnings as a tax-exempt fund for retirement, currently called an IRA or a 401-k fund. Your income taxes for the current year will be tax-sheltered, up to the amount taxed on the amount you contribute. It's a good thing to get one of these funds started as soon as you are legally able to do it, so the mechanics are completed while the amounts are still small. The suggested funds are the ones with the smallest administrative costs, which will probably be no-load index funds; if the fund you choose has more than a trillion dollars under its control, you are probably reasonably safe. Try to keep depositing automatically, right up to the maximum amount allowed by the law, right up to the day you die if they will let you, and select the option of automatically re-investing any dividends. Until these vehicles were created, just about the only tax-exempt investments anyone could buy were tax-exempt municipal bonds, and life insurance. Both of these vehicles have some major disadvantages; the IRA and 401-k mechanisms allow you to apply the tax exemption to just about any investment you choose, so they are just as good as anything you can buy, plus having the advantage of being tax sheltered. If anyone proposes investments other than IRA/401-k before you exhaust the limits of these, that person has some serious explaining to do; at the very least get a second opinion. It will be a rare person under the age of forty, perhaps an entertainer or professional athlete, who has money left to invest after fully exhausting the tax exemptions. That's because the typical young person takes on the burden of buying a house or paying for private education for children, and there just isn't enough money to go around.

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Life Insurance

Life Insurance is a comparatively poor investment, and it is an even worse investment if it is purchased without investigation or comparison shopping. Some insurance companies, like Northwestern Mutual, have considerably better results than the average, and some other very large, very famous "leading" life insurance companies have pretty inferior results. Life insurance does provide some tax exemption, however, which varies a little between states as a result of the McCarran Fergusson Act of 1945. However, the legislation does produce tricky features, like tax-exempting either the owner or the beneficiary of the policy, but not both. The entire first year premium is ordinarily paid to the salesman as a commission, and sometimes the commissions continue for life. But that is only part of the incentive which the life insurance salesman has for selling excess coverage. The other incentive is worth serious pondering: a main source of life insurance profits derives from the large number of clients who pay premiums for a while, and then drop the policy without collecting on it. The deplorable national statistics on temporary job loss, personal bankruptcies, and divorce carry implications of considerable weight for the purchase of life insurance; investment is limited to what you happen to have, but life insurance is based on projections of what you hope to have, or what you fear.

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