financial planning and the unknowability of the future

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camillus
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financial planning and the unknowability of the future

Post by camillus » Thu Aug 09, 2018 1:19 pm

Hi all,

I am noticing in my thinking that I am trying more to abide by the principle of the future's unknowability, the future being more "unknowable" the farther out it gets. Therefore, I try to make decisions that benefit me most in the nearer term, say within 5 or 10 years.

For example, I prefer to contribute to a workplace deferred account (account A) in order to maximize present day tax avoidance although I could contribute to another account, a traditional or Roth IRA (account B), with lower expense ratios. Near term, the one account gives substantial tax savings. Long term - as in 20 and 30 years - the account balances get so large that the difference in expense ratios tips the balance the other way.

In order to favor "account B" for present day contributions, you have to hold several assumptions constant over the next decades, like expense ratios staying static, staying with the same employer, and bits of legislation staying the same. My opinion is that doing math based on constants over 20-30 years, the numbers get weird, and one is led to make perhaps irrational choices in the present term.

Do you find yourself weighing near term benefits against possibly better long term benefits because of "the future?"

Other examples of this might include:
1) contributing to Roth or Taxable before a 529, though being determined to help your kids through college
2) contributing to tax deferred accounts though your tax bracket in retirement *might* be higher
3) contribute to HSA via payroll deduction, thus bypassing FICA, though contributing to social security might be a better idea
4) in terms of time savings and mental overhead, simplicity in one's portfolio vs slice and dice

I just wanted to discuss the general principle and perhaps identify a few other examples. I've been trying to articulate this in discussions with friends and was wondering if anyone else here could contribute to my thinking. Thanks!
Last edited by camillus on Thu Aug 09, 2018 2:11 pm, edited 1 time in total.

livesoft
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Re: financial planning and the unknowability of the future

Post by livesoft » Thu Aug 09, 2018 1:34 pm

I know what you are saying, but I must admit that I didn't think too hard about any of it and didn't analyze anything in depth.
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grok87
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Re: financial planning and the unknowability of the future

Post by grok87 » Thu Aug 09, 2018 1:42 pm

camillus wrote:
Thu Aug 09, 2018 1:19 pm
Hi all,

I am noticing in my thinking that I am trying more to abide by the principle of the future's unknowability, the future being more "unknowable" the farther out it gets. Therefore, I try to make decisions that benefit me most in the nearer term, say within 5 or 10 years.

For example, I prefer to contribute to a workplace deferred account (account A) in order to maximize present day tax avoidance although I could contribute to another account, a traditional or Roth IRA (account B), with lower expense ratios. Near term, the one account gives substantial tax savings. Long term - as in 20 and 30 years - the account balances get so large that the difference in expense ratios becomes tips the balance the other way.

In order to favor "account B" for present day contributions, you have to hold several assumptions constant over the next decades, like expense ratios staying static, staying with the same employer, and bits of legislation staying the same. My opinion is that doing math based on constants over 20-30 years, the numbers get weird, and one is led to make perhaps irrational choices in the present term.

Do you find yourself weighing near term benefits against possibly better long term benefits because of "the future?"

Other examples of this might include:
1) contributing to Roth or Taxable before a 529, though being determined to help your kids through college
2) contributing to tax deferred accounts though your tax bracket in retirement *might* be higher
3) contribute to HSA via payroll deduction, thus bypassing FICA, though contributing to social security might be a better idea
4) in terms of time savings and mental overhead, simplicity in one's portfolio vs slice and dice

I just wanted to discuss the general principle and perhaps identify a few other examples. I've been trying to articulate this in discussions with friends and was wondering if anyone else here could contribute to my thinking. Thanks!
interesting post. I personally find it helpful, in these short-term vs long-term situations, to think about things from a "risk" angle. So for example on your 2) and 3) above:

2) if your tax bracket in retirement is higher then perhaps your future self is well off? if your tax bracket in retirement is lower, then perhaps your future self is poor. in this second case you'll probably be glad you contributed to tax deferred accounts. so to hedge against the risk that your future self is poor you should contribute to tax-deferred accounts.

3) social seccurity has a couple of bend points and once you are past the second there are diminishing returns to contributing to social security
https://www.ssa.gov/oact/cola/piaformula.html
probably tough to come up with a general rule, but my guess is that for most folks contributing to the HSA is better value, hedges the risk that your marginal dollar of payroll doesn't get you much in the way of social security benefits...

cheers,
grok
Keep calm and Boglehead on. KCBO.

livesoft
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Re: financial planning and the unknowability of the future

Post by livesoft » Thu Aug 09, 2018 1:54 pm

A book that helps with decision making has been mentioned several times on the bogleheads.org forum: Decisive by Heath & Heath.

The book is not explicitly about the decisions discussed in the opening post, but is a general treatise on the process of decision making with many practical examples on what's important and what's not important, so I think a mention belongs in this thread.
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KlangFool
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Re: financial planning and the unknowability of the future

Post by KlangFool » Thu Aug 09, 2018 2:02 pm

OP,

My portfolio is spread across all 3 types of accounts: Tax-deferred (45%), Taxable (45%), and Roth IRA (10%). So, I have maximum flexibility to deal with whatever future holds.

It is very simple.

Maximized your tax-deferred accounts. Put the tax savings into the Roth IRAs and the taxable account. Then, you have maximum flexibility to deal with the future.

KlangFool

Mike Scott
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Re: financial planning and the unknowability of the future

Post by Mike Scott » Thu Aug 09, 2018 2:08 pm

You should be aware and plan based on what you know and even calculate some of those long term future numbers. Just remember that you are still guessing about an unknowable future no matter how precise some of those future numbers seem to be. I think that diversification including tax diversification is one way to approach the unknowable. I think that another approach should be a thoughtful re-evaluation as you get new and different information. More generally, most of us like certainty but since we can't get it we must develop a coping mechanism of some sort or else we would never be able to make a decision or plan anything.

gmaynardkrebs
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Re: financial planning and the unknowability of the future

Post by gmaynardkrebs » Thu Aug 09, 2018 2:22 pm

I agree with you on the Roth, as I'm seeing a big VAT in my tea leaves.

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FIREchief
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Re: financial planning and the unknowability of the future

Post by FIREchief » Thu Aug 09, 2018 2:32 pm

grok87 wrote:
Thu Aug 09, 2018 1:42 pm
camillus wrote:
Thu Aug 09, 2018 1:19 pm
2) contributing to tax deferred accounts though your tax bracket in retirement *might* be higher
2) if your tax bracket in retirement is higher then perhaps your future self is well off? if your tax bracket in retirement is lower, then perhaps your future self is poor. in this second case you'll probably be glad you contributed to tax deferred accounts. so to hedge against the risk that your future self is poor you should contribute to tax-deferred accounts.
I agree with this 100%, and it is the exact reasoning I used during my later accumulation years to choose between traditional and Roth investments. I maximized the pre-tax, because there was a possibility that things would not go well (career, investments, etc.) and I *could* wind up in a very low tax bracket in retirment. I was willing to risk sub-optimization if things went as expected (or better than expected).

This isn't the first time I've seen this thought process on the forum, but I don't think we see it often enough. 8-)
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

JBTX
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Re: financial planning and the unknowability of the future

Post by JBTX » Thu Aug 09, 2018 2:34 pm

Traditional vs Roth. This has been debated ad nauseum. I'm roughly 50/50 traditional / Roth. 5-10% taxable. In our case I probably won't have a long pre social security retirement window to do Roth conversions. There are other benefits to Roth specific to our situation.

529. Have enough to cover one child approx 2-3 years public school. I stopped contributing to it many years ago when it became questionable as to whether one or both kids would go to college

I'm no longer eligible for HSA but always contributed when I was. I'm sure the tax benefit far exceeds the incremental social security loss (and I may have been over limit I don't recall). I usually liquidated the HSA on medical expenses in a year or two.

I do slice and dice but would likely be better off with more simplicity.

JoeRetire
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Re: financial planning and the unknowability of the future

Post by JoeRetire » Thu Aug 09, 2018 3:37 pm

camillus wrote:
Thu Aug 09, 2018 1:19 pm
2) contributing to tax deferred accounts though your tax bracket in retirement *might* be higher
Everyone's tax bracket in retirement might be higher. Nobody can predict what the tax brackets might be down the road.
3) contribute to HSA via payroll deduction, thus bypassing FICA, though contributing to social security might be a better idea
I'm trying and failing to come up with a scenario where "contributing to social security" would be a better idea. Can you elaborate?

KlangFool
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Re: financial planning and the unknowability of the future

Post by KlangFool » Thu Aug 09, 2018 5:49 pm

JoeRetire wrote:
Thu Aug 09, 2018 3:37 pm
camillus wrote:
Thu Aug 09, 2018 1:19 pm
2) contributing to tax deferred accounts though your tax bracket in retirement *might* be higher
Everyone's tax bracket in retirement might be higher. Nobody can predict what the tax brackets might be down the road.
3) contribute to HSA via payroll deduction, thus bypassing FICA, though contributing to social security might be a better idea
I'm trying and failing to come up with a scenario where "contributing to social security" would be a better idea. Can you elaborate?
JoeRetire,

I believe OP is still at the pre-first bend point region. So, the benefit is credited at 90%.

KlangFool

carolinaman
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Location: North Carolina

Re: financial planning and the unknowability of the future

Post by carolinaman » Fri Aug 10, 2018 8:32 am

I like to factor in a range of possible outcomes for long term planning, using an expected, best and worst cases. It is still a guess but it gives you an idea of what outcomes you might experience. I also try to be conservative about the long term, giving myself a cushion. However, you can overdo that sort of thing, unnecessarily sacrificing today for the future.

The actuaries for our state pension system use 11 different assumptions (inflation, investment returns, etc.) in projecting long term liabilities for the pension system. This projection determines the financial health of the system and also what current employer contribution rates are needed. They say they know one thing for certain: they will be wrong. Some of their assumptions will miss, some by a good margin. But what is the alternative, a ouija board? They do this every year and adjust contribution rates accordingly. This process is similar to what we all should do. We cannot predict the future. But we can assess our situation each year and make adjustments (perhaps increasing your contribution rate?) as needed. I much prefer this approach to an overemphasis on the short term.

grok87
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Re: financial planning and the unknowability of the future

Post by grok87 » Fri Aug 10, 2018 10:11 am

FIREchief wrote:
Thu Aug 09, 2018 2:32 pm
grok87 wrote:
Thu Aug 09, 2018 1:42 pm
camillus wrote:
Thu Aug 09, 2018 1:19 pm
2) contributing to tax deferred accounts though your tax bracket in retirement *might* be higher
2) if your tax bracket in retirement is higher then perhaps your future self is well off? if your tax bracket in retirement is lower, then perhaps your future self is poor. in this second case you'll probably be glad you contributed to tax deferred accounts. so to hedge against the risk that your future self is poor you should contribute to tax-deferred accounts.
I agree with this 100%, and it is the exact reasoning I used during my later accumulation years to choose between traditional and Roth investments. I maximized the pre-tax, because there was a possibility that things would not go well (career, investments, etc.) and I *could* wind up in a very low tax bracket in retirment. I was willing to risk sub-optimization if things went as expected (or better than expected).

This isn't the first time I've seen this thought process on the forum, but I don't think we see it often enough. 8-)
thanks
Keep calm and Boglehead on. KCBO.

Iridium
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Re: financial planning and the unknowability of the future

Post by Iridium » Sat Aug 11, 2018 12:03 am

camillus wrote:
Thu Aug 09, 2018 1:19 pm
For example, I prefer to contribute to a workplace deferred account (account A) in order to maximize present day tax avoidance although I could contribute to another account, a traditional or Roth IRA (account B), with lower expense ratios. Near term, the one account gives substantial tax savings. Long term - as in 20 and 30 years - the account balances get so large that the difference in expense ratios tips the balance the other way.
I do not see why your analysis would have anything to do with 401k vs traditional IRA. You get the same size immediate deduction with both. The tipover point is immediate, since you start off at the same place immediately (per the context of the paragraph, I am assuming no employer match and that your income is low enough to deduct traditional contributions).

The Roth will likely never tip over due to ER difference, unless you are in a truly atrocious employer plan. Your Roth would have less money in it than the 401k for your entire retirement. However, you would also have less taxes. Which leaves you with more to spend in retirement at the end of the day depends on the tax rate now vs retirement (if they are the same, then a traditional IRA and Roth IRA will perform exactly the same).
camillus wrote:
Thu Aug 09, 2018 1:19 pm
1) contributing to Roth or Taxable before a 529, though being determined to help your kids through college
This one seems to contradict the rest. Retirement is many decades away, whereas college is in 10-15 years.
camillus wrote:
Thu Aug 09, 2018 1:19 pm
I just wanted to discuss the general principle and perhaps identify a few other examples. I've been trying to articulate this in discussions with friends and was wondering if anyone else here could contribute to my thinking. Thanks!
I really don't think you are discounting the long term for the short term. Otherwise, you would not even be saving for retirement. So far, I would describe it more that you dislike uncertainty. You are more certain of your retirement than your kids' college (maybe they go to military college or trade school or get a scholarship or college tuition becomes free somehow). You are more certain of the 401k tax benefit than the Roth benefit (even though a sober analysis may reveal that the Roth benefit is more valuable).

2015
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Re: financial planning and the unknowability of the future

Post by 2015 » Sat Aug 11, 2018 11:53 am

KlangFool wrote:
Thu Aug 09, 2018 2:02 pm
OP,

My portfolio is spread across all 3 types of accounts: Tax-deferred (45%), Taxable (45%), and Roth IRA (10%). So, I have maximum flexibility to deal with whatever future holds.

It is very simple.

Maximized your tax-deferred accounts. Put the tax savings into the Roth IRAs and the taxable account. Then, you have maximum flexibility to deal with the future.

KlangFool
This. What I did pre-retirement which has supported maximum flexibility (excellent phrase, BTW) in retirement.

KlangFool
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Re: financial planning and the unknowability of the future

Post by KlangFool » Sat Aug 11, 2018 12:01 pm

Iridium wrote:
Sat Aug 11, 2018 12:03 am
camillus wrote:
Thu Aug 09, 2018 1:19 pm
1) contributing to Roth or Taxable before a 529, though being determined to help your kids through college
This one seems to contradict the rest. Retirement is many decades away, whereas college is in 10-15 years.
Iridium,

Money is fungible. Why can someone not use his/her money in the taxable account and Roth IRA contribution to pay for college? I am using my taxable account and annual savings to pay for my kids' college education now. In fact, to maximize tax efficiency, I am moving my money from the taxable account to Trad. 401K and Roth IRA while doing this.

This the tax efficiency of one portfolio.

KlangFool

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