10.26.2019

Ric Edelman is wrong on Roth 401(k)s and dollar-cost-averaging withdrawals

I'm a huge Ric Edelman fan. I'm a regular listener of his radio show and believe he's made a huge positive contribution to the financial literacy of America.

But he sometimes makes some really bone-headed mistakes. The past couple weeks have had some big ones on his radio program.



Roth vs. Traditional 401(k)

Last weekend's (10/19/19, minute 48) radio show had a caller ask about Roth vs. 401(k)s. The caller correctly made the observation that post-tax (Roth) contributions effectively allowed you to contribute more money, but Edelman rejected the argument:
"It doesn't matter. In other words, investing $10 now and paying the taxes later or investing $8 now and not paying taxes later, it's the same math. It doesn't make any difference."
Obviously this assumes constant tax rates now and in retirement, which, though unrealistic and unpredictable, we'll stipulate for simplicity.

But the big problem is that the caller is not asking about choosing $10 in one vs. $8 in the other. The caller is asking about contributing the maximum. The maximum contribution is $19,000 ($25,000 for those over 50) in either the Roth or the traditional (or in any combination of the two). The caller is right: contributing $19,000 post-tax in a Roth is effectively more money than $19,000 pre-tax in a traditional.

Here's the math. Assume Edelman's constant 20% tax rate. Assume your $19,000 contribution triples by the time you retire to $57,000. Your Roth 401(k) is now $57,000 tax-free. Your traditional 401(k) is also $57,000, but you owe $11,400 in taxes, leaving you only $45,600 after tax. Roth wins!

Now Edelman might object: "OK, but you saved $3800 up front with the traditional 401(k) and you're not accounting for that." Correct. But if you invest that money in a taxable account that earns similar returns and triples by retirement, you'll pay dividend income tax and capital gains tax along the way, and you'll owe capital gains on the whole thing when you cash out. It's still not as good as the Roth!

I don't think Edelman has ever thought through the numbers in this way. His answer holds true only if you're contributing less than the maximum. If you're trying to max out your retirement funds, Roth is the unquestionable mathematical winner.

But then at then end it gets worse. Edelman completely Costanzas his conclusion when the caller says he thinks tax rates will be higher in the future. "If that's true, then you would much rather pay the taxes today at today's lower rate. That argues for the deductible account, not the Roth." WRONG! That argues for the Roth, not the deductible!

Note: though the above math clearly argues for Roth being superior under current law, we have absolutely no idea what future Congresses or roving hordes of woke Millenials will do. A move toward VAT or other consumption taxes would reduce the relative attractiveness of Roths. In an unknowable future, the best idea is tax diversification: put some in Roth, some in traditional, some in taxable brokerage accounts, some in gold and lead.



Dollar-cost-averaging withdrawals


Today's show (10/26/2019): A caller asked a very insightful question: if dollar-cost-averaging (buying equal dollar amounts on a regular schedule) is a great way to add money into the market because you're buying more shares when the market is low and fewer when the market is high, wouldn't that mean that equal monthly withdrawals (i.e. dollar-cost-averaging-OUT) in retirement are a bad idea? You'd be selling more shares when the market is low, and fewer shares when the market is high.

The caller was absolutely correct, but Edelman either didn't understand the question or just blew it off and said that, no, dollar-cost-averaging withdrawals is just fine.

Edelman was wrong mathematically, of course, but perhaps would argue that the simplicity of getting a regular monthly check outweighs the small financial losses you're taking by selling at worse average prices.

What's an alternative withdrawal strategy that doesn't fall into the reverse-DCA trap? You could withdraw a fixed percentage of your portfolio value - say 1% ever quarter. Even better, you could decide to withdraw more in periods where your portfolio value or recent return was above target, and less in periods when your portfolio is down. You could put the boom years' extra withdrawals in cash and short-term investments to cushion your spending in the down years.



I still like Rick Edelman, but he says flatly wrong things with a little too much confidence

Thoughts on a #TradeWarTuesday

1) We're going to need to decouple from the evil Chinese regime. This started as a crazy Trump position but is now bipartisan consensus....