Invest like you live here

I was reading an article last week about income inequality both before and after taxes across the world and it got me to thinking about how the rich use strategies to reduce the amount of taxes they pay. Many people think these strategies are only for the wealthy but as I have pointed out in past posts, there are a number of tax and wealth strategies that are available to everyday people, as long as they are willing to learn a bit.

The article discusses the Gini coefficient across different countries. The Gini coefficient is an index which measures income inequality in an economy and ranges from 0 for income equally shared across the population to 100 where 1 person would make all the income for themselves. The authors plotted the Gini coefficient based on gross income before taxes and then the coefficient after taxes and “transfers” meaning programs for the poor and subsidies. The plot is displayed below.

Source: The Economist

It’s takes a minute to sink in what the chart is telling you but basically it’s saying that the further the line moves left for each country the better job it does at taking unequal income and making it more equal.

The author claims the US does a pretty decent job of trying to make things more fair but that it’s starting from such high income inequality in the first case that it’s hard to make up all that ground.

Ireland has a special case since it has a lot of corporations domiciles there that they tax lightly but redistribute heavily within the country. Chile and Mexico are some scary cases as they barely redistribute anything and have even higher income inequality.

This Isn’t Your Dad’s Age

There is no simple cure to this issue and policy makers have been trying for years to figure out ways to encourage ordinary people to save and invest with mixed results. Long gone are the days when a worker could expect a wage that could take care of a family and have a pension that would guaranty his or her retirement.

That pension was free though, it was essentially forced saving, much like social security is actually forced saving. You didn’t have the option to dip into your pension so the temptation was not there. You just worked your years and the company made a promise to take care of you while a professional pension manager siphoned off funds from the company and professionally managed them to make sure that promise was kept when it was time to retire.

However as the destroyed industrial economies in Europe and Asia rebuilt after World War II they started to push into the open US market and create competition for many of the US brands. Throw in development in recent years from emerging economies that essentially have 19th century style factory environments and it became extremely difficult more many American companies to comete with their expensive workers and their expensive pensions.

The Aftermath

What we were left with was essentially a mostly privatized retirement system that would be privately funded by individual workers with government incentives.

However studies show time and time again that people are just not saving enough for retirement. A study by the Economic Policy Institute shows the average retirement account balance by age type up to 61 below.

Source: epi.org

What is really alarming is the average balance of those 56-61 or less than a decade away from the classic retirement age of 65. This is not nearly enough to live, pay higher medical costs and get extra help if one gets more frail, even with social security. It’s no wonder we are seeing more and more people work past retirement age in the US, they just haven’t saved enough to retire.

I have noticed on sites I write for such as Seeking Alpha that this has produced a large community of older amateur investors focused on risky high dividend stocks like mortgage REITS or Business Development Corporations (BDC’s). They are just trying to squeeze as much current income out of their portfolios in the hopes that they can push the nest egg forward a few more years.

There Are Tools Available

The stock market is a powerful tool and as I have pointed out in my post called It Has Never Been Easier to Invest and Get Rich investor friendly index funds that almost always have a positive return in the long run are a great tool to take advantage of the power of long term compounding. Sadly it seems that almost half of American households are missing out as they have no investments in stocks while 84% of the entire stock market is held by the top 10% of income earners as this NYU study pointed out in 2017. You can see the visualization provided in the study below.

Source nber.org

But fear not because below I am going to present some of the tools geared towards lower income people that can be great tools to climb yourself into middle and even upper class over time without doing anything spectacular.

• The Roth IRA – For single people making under $137,000 or married couples making leas than $203,000 you can contribute up to $6,000 annually to a Roth IRA which will never be taxed again. It’s a great gift to give to your kids and then put a little money in as they work their first lower income jobs. That money can grow to huge sums of left along over someone’s lifetime.

• A 401k – Most people know about this but one thing looking back I wish I would have done is try to get close to the personal maximum in years past. For 2019 this amount is $19,000 and it’s key to remember that any matching or profit sharing from your company is not included in that amount. Let’s say your match is 3% and you put away the whole $19,000 yourself on an $80,000 salary. That means you really saved $21,400.

• An HSA – Healthcare plans are getting worse lately and I am not happy about my high deductible plan. However the HSA or Health Savings Account, does offer tax advantages. It’s triple tax deductible which means it reduces your income taxes, can grow tax free and funds can be withdrawn tax free for medical expenses. The option on my plan I find very attractive is that I can invest the funds into a mutual fund which can compound over many years if I don’t draw it down too much. Just like a 401k it’s yours when you leave the job so if you save and invest aggressively over many years in an HSA, you can build a fund for medical expenses when you are older.

• Plain Old Investing – Long term capital gains (selling a stock for a higher price after one year or more ownership) and qualified dividends have $0 taxes placed on them by the federal government if you make under certain amounts. If you are in a state with no income tax like Texas or Florida, you can essentially make gains for free. If this isn’t a huge incentive for low income people to invest I don’t know what is. Even the 15% rate above those thresholds is generous. With brokerages like Robin Hood and low cost index funds it has likely never been more advantageous for low income people to invest in the market and see real gains.

Source: fool.com

• An Advisor – Wealth Planning is no longer for the rich, Vanguard offers an advisor to guide you for 0.30% of your portfolio. There are even robo advisors of various prices, or even for free, that tell you how to adjust your portfolio. This democratization of wealth advisory is a true revolution that could potentially change the game in terms of smart investing and participation by more people.

• Discipline – Its as much mental as it is knowing what to do. Turning off the financial news, dollar cost averaging and investing for the long term, are things that require vision and discipline but they are habits that can be learned. To help you visualize, take a look at returns of stocks, bonds and a 50/50 stocks and bonds portfolio over 1, 5, 10 and 20 years and see the highest and lowest returns. Even through bad times over decades, the market and diversification can provide you returns that outpace inflation.

Source: Barclays

Conclusion

Don’t be intimidated by what the rich do, there is no magic and this is one of the best times in history in the sense that so many ordinary people now have access to tools that were once only for the very rich. I strongly encourage everyone to give investing a look and take the leap towards a more balanced future.

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