Category Archives: Financial Literacy

The Manifesto of the Financial Educator

As a financial researcher and aspiring financial educator, I’ve been thinking at length about the principles behind good financial teaching. These five ideas are by no means new or original. However, they are research-supported and not yet mainstream.

1. Behavior Under Management

Know when the student is not ready.

This is straight from Andy Hart’s podcast and conference, with support from a wealth of research in behavioral psychology, economics, and personal finance. Emotion, perception, knowledge, and experience all play an important role in why people make bad financial decisions.

It is widely accepted that younger people should be fully invested in stocks, because their time horizon is long. As they get older, volatility and profits should both be suppressed by divesting stocks into safer, less profitable assets such as bonds. However, young people commonly freak out when there is a bear market, selling their investments and even losing part of their principal. This is traumatic and may result in them never investing in stocks again, which is a worse outcome than if they had invested later in life with greater knowledge, experience, and resilience.

It is not fair to a student to advise an objectively superior course of action when it will lead to financial ruin because the student is not ready.

2. Educate in Arithmetic and Statistics

When the odds are in your favor, it’s only “gambling” if the consequences are disastrous.

Recent evidence suggests that mathematical education may be more important than financial education. The ability to perform mental computations is important, as well as skill with picturing compound interest and percentages. Understanding risk and reward over time is critical. Anyone with a complete understanding of gambling mathematics should know that as you gamble more, you get closer and closer to a guaranteed loss of money.

Investing in the whole global stock market, on the other hand, is neither speculation nor gambling because the odds are in your favor and the consequences of loss are temporary. Although the market declines in about 25% of given calendar years, over longer spans it almost surely increases from the starting point.

Insurance companies make money because they pay out less money than they take in. On average, the odds are in their favor. For any one individual or family, however, the consequences of losing the bet are disastrous. This is why it is wise to purchase health insurance, term life insurance, auto insurance, et cetera. You are insuring against uncommon yet disastrous events. Nonetheless, these disastrous events are much more likely to occur than winning a large lottery jackpot. On the other hand, purchasing insurance against minor losses, like a SquareTrade warranty or collision insurance on a car, is only necessary if these items are critical to you and you do not have the funds to replace them.

3. Make Choices Simpler

Don’t do business with businesses that put bad choices on the table. (Unless you are beating them at their own game.)

People often ask why one should pick Vanguard over Fidelity, Charles Schwab, or another firm for directing their investments. Although Fidelity and Schwab do offer low-cost index funds and arguably offer superior customer service, they are also determined to sell you on products and services that are very bad for your financial health, such as actively managed investments with high management fees.

It is an unpleasant and cognitively taxing experience to be required to repeatedly decline detrimental options. The extended warranties that are sold at the checkout counter at Best Buy are an awful deal. Likewise for trip “insurance” from your airline and GoDaddy’s upsells of inferior hosting services and over-priced options when all you want to purchase is a simple Internet domain name. It is bad enough when a business puts bad choices on the table; aggressive sales tactics are the coup de grâce.

This is why a hard rule of using cash instead of plastic is effective and beneficial for most consumers. The exception is if you are a “travel hacker” beating the credit card issuers at their own game. If you have to ask, you’re not a travel hacker. Simplifying the equation by avoiding the potential for making bad choices is worth losing a few benefits that are, by comparison, small. In some industries, all the major players violate this rule. However, when there an alternate option is available, it should usually be preferred (e.g., Vanguard, cash or debit cards instead of credit cards, etc.).

4. Inculcate a Habit of Inquiry

The squeaky wheel gets the grease.

There is plenty of information available easily via web search. For example, you can easily learn about investing, retirement accounts, or strategies for convincing your bank to waive an overdraft fee by searching Google. However, many people are not in the habit of seeking information nor asking for special consideration from a lender, bank, et cetera. There are differences between how subject-matter experts and novices seek information; novices may not know where to begin, and are typically unfamiliar with the jargon of personal finance, insurance, taxes, credit cards, mortgages, student loans, credit-reporting bureaus, and more. Therefore, it is unfair to blame them for failing to seek out information. Instead, we should educate them in the basics and encourage them to build a habit of inquiry, so they less likely to be shortchanged in their financial dealings.

In addition to educating others, we should lobby for laws and regulations that compel employers and financial institutions to conduct business in ways that do not unfairly disadvantage the non-wealthy (e.g., comprehension rules), and advocate for prosocial behaviors among employers, financial institutions, corporations, and governments that benefit the poor. For instance, it is unfair that many government benefits are not received by the most needy, due to being difficult to claim.

5. Focus on Long-Term Lifestyle Strategy

But, give tactical advice when appropriate.

Reducing bills, increasing income, and changing one’s habits is important. There are many forums and other websites about living frugally. In some ways this overlaps with Item 4; for example, one can save quite a bit on a car, phone or cable bill, rent, or terms of debt service by inquiring with sellers, service providers, landlords, and lenders. Responsible financial educators should encourage learners to (a) reduce expenses as a way of life (e.g., smaller living space, more roommates, no dining out, etc.), (b) focus on significantly increasing income by leveraging education, skills, et cetera, and (c) eliminate debts, save, and invest.

Financial education appears to be more effective when it either focuses on norms and general principles or is given tactically (i.e., “just-in-time“). The best time to tell someone how to write a check is immediately before they need to write a check. Financial advisers can serve as financial educators by offering key information and advice soon before significant financial events such as shopping for a house and mortgage. On the other hand, if this advice is offered many months or years in advance, it is neither remembered nor followed.

Optionally/additionally as a grammatical alternative to and/or when the prior item(s) are essential

The grammatical construct “and/or” is frequently criticized for being unnecessary and/or ambiguous.

As a logical operator, when used in a list of two things (e.g., rice and/or beans), it implies that it is acceptable to have:

  • Item 1
  • Item 2
  • Items 1 and 2

However, having no items is unacceptable.

When used in a list of three things (e.g., rice, beans, and/or salsa), it implies that it is acceptable to have:

  • Item 1
  • Item 2
  • Item 3
  • Items 1 and 2
  • Items 1 and 3
  • Items 2 and 3
  • Items 1, 2, and 3

However, having no items is unacceptable.

This, obviously, is quite vague. Some have suggested just using “or” instead of and/or. However, “or” is also ambiguous in common language. This may be why APA style tolerates and/or, neither endorsing nor forbidding it.

Due to its vagueness and a lack of viable alternatives, and/or is used in many situations where it does not apply. One common instance is using and/or when you really mean to say “this item can be added, but the prior items are essential.” To address this, I propose a new grammatical construct: optionally/additionally.

Optionally/additionally has all the slashy goodness of and/or, but an air of sophistication. Sure, you could just say “and optionally,” but this isn’t strong enough at conveying that the subsequent item or items are optional add-ons, while simultaneously conveying that the prior item or items was/were essential.

For instance, when suggesting how to invest in equities, I would advise investing in a mutual fund of the whole U.S. stock market and optionally/additionally the whole international stock market (encompassing the whole world except the United States—the US is about 50% of the global market by market capitalization and all other countries sum to about 50%).

I would not want to say “the whole U.S. stock market and/or the whole international stock market” because the first item is essential, while the second item is not (depending on how bullish you are on the United States).

Of course, there are index funds that combine both the U.S. and international markets. For the equities portion of a portfolio, it would be fine to suggest investing in the whole U.S. stock market or the whole world stock market, but if we replace “whole world” with “international” (all other countries except the US), neither “or” nor “and/or” are acceptable, because both imply the first item is optional rather than mandatory. This is an example of when the optionally/additionally construct is useful.

I did not do extensive research into whether someone else has addressed this conundrum of grammar and logic. Please reply if you know of such sources. A Google search shows that optionally/additionally has been used three times before, but without elaboration on the grammatical or logical implications:

  1. On 2010-03-14, “GrapefruiTgirl” made this statement on the forum: Optionally/additionally, as your regular user, enter your ~/.fonts folder (or create it of there is none) and repeat the above three commands as regular user.
  2. On 2010-04-25, Michael S. from Vienna, Austria made this statement on TripAdvisor: Take the first train to Innsbruck which is a nice little city surrounded by majestic mountains. The city has a small but fine city center and you can easily and quickly go up to 2.300m above sea level by ropeway. Ex Innsbruck you could optionally/additionally visit the Karwendel Area with places like Seefeld and Mittenwald. The Karwendel Railway is known for spectacular views. Prepare for a long day but it is feasible!
  3. On 2016-11-15, “horst” made this statement on the application programming interface (API) discussion board in the ProcessWire content management system (CMS) forum: Optionally / additionally interesting in this regard maybe the weighten option of Pia here.

From these examples it appears optionally/additionally is most relevant to fastidious Austrians and computer programmers, but its slashy goodness remains undiscovered by the rest of Googleable humanity. A search of additionally/optionally reveals more than 20 uses, but I prefer emphasizing the optionality before communicating the supplementary nature of the subsequent items (and, consequently and implicity, the necessity of the preceding items), so additionally/optionally is of less interest to me.

A Thematic Literature Review on Financial Capability and the Effectiveness of Financial Education in America After the 2008 Financial Crisis

I completed this literature review on 2018-04-23 for IDS 7500: Seminar in Educational Research (self-directed study) at University of Central Florida. I will need to expound upon it in my dissertation, which will be focused on financial education.

A Thematic Literature Review on Financial Capability and the Effectiveness of Financial Education in America After the 2008 Financial Crisis
Richard Thripp
University of Central Florida

The purpose of this literature review is to investigate Americans’ financial knowledge and capability since the 2008 financial crisis (also known as the Great Recession), by synthesizing empirical research and position papers into a thematic narrative, with a focus on the refereed publications of leading researchers in the financial education space, such as Lusardi, Mandell, Mitchell, Mottola, and Willis. Articles are included based on authorship and their relevance toward this objective, with additional articles gleaned from leading researchers’ citations. Because of the breadth of the relevant literature, the focus herein is on explaining and adequately substantiating phenomena, rather than systematic coverage.


Firstly, we should discuss the meanings of financial knowledge, financial literacy, and financial capability. These terms are inconsistently defined in the literature, but, generally, they are in order of scope. Financial knowledge relates to content knowledge and is often used as a proxy for financial capability (e.g., Lusardi, Mitchell, & Curto, 2010). Financial literacy additionally includes the ability to articulate one’s knowledge and apply it to real-life decisions (Vitt et al., 2000), while financial capability more prominently emphasizes improvement of one’s actual financial behaviors. A key distinction is that having financial knowledge does not actually mean one’s financial decisions will improve, and being taught about financial concepts does not mean that information will necessarily be retained. In the literature, financial knowledge and financial literacy are conflated or treated synonymously, while financial capability is often treated synonymous to financial literacy (Remund, 2010), but consistently refers to a construct more holistic than financial knowledge.


Before the Crisis

Based on fifteen years of Survey of Consumer Finances data, Hanna, Yuh, and Chatterjee (2012) found that consumer debt increased, with 27% of households having more than 40% of their income going toward debt payments in 2007 as compared with 18% in 1992. Although the time leading up to the Great Recession was prosperous, it was also marked by financial institutions’ heavy over-extension of credit which resulted in unsafe debt proportions among American households, and particularly among more highly educated households. These debts, combined with a stock market plunge and widespread job loss, compounded the negative effects for many American households, which persist even a decade later. The crisis also brought about a renewed focus on financial education.

Financial Education Movement

A movement in support of financial education emerged in response to the Great Recession. The Jump$tart Coalition for Personal Financial Literacy, a Washington, D.C. think-tank funded by the U.S. government and corporations like Charles Schwab and Bank of America, gained increasing clout. The organization’s National Standards in K–12 Personal Finance Education, now in its 4th edition (2015), increasingly became adopted by states and school districts throughout the US. While the movement gained momentum, several commentators complained about financial education on a theoretical basis—most notably, Willis (2008, 2009) who likens the movement to teaching citizens to represent themselves pro se in court or to perform their own medical procedures. More recently, Pinto (2013) argued that the movement is misguided in both its suggested implications and underlying assumptions. Later, we will see that unfortunately, there is also empirical support for this position.

Perceived Financial Capability

The National Financial Capability Study (NFCS) is a nationwide triennial survey of over 25,000 Americans that measures their financial position, attitudes, and content knowledge (for more information, see Mottola & Kieffer, 2017). It includes several questions asking respondents to rate their mathematical and financial abilities on seven-point Likert scales—we might refer to these questions as a proxy for self-perceived financial capability. An analysis of responses to these items in the 2009 NFCS survey shows a correlation between perceptions and actual financial knowledge (de Bassa Scheresberg, 2013), but also shows that Americans grossly overestimate their financial prowess. Such overconfidence can have detrimental consequences.

Measures and Proxies of Actual Financial Capability

Here, we will look at recent research on Americans’ financial capability, or proxies thereof (i.e., numeracy, financial knowledge, and financial behavior).


Numeracy, broadly, is the ability to understand and manipulate numbers, including basic mental arithmetic. These skills are closely associated with financial capability, yet sadly are consistently lacking among Americans, especially among those who are already financially at-risk such as senior citizens, women, and those with less educational attainment (Lusardi, 2012). A striking investigation is Lusardi and Mitchell’s (2007) analysis of 2004 survey data of Americans aged 51–56, which focused on three basic questions assessing numeracy. One asked how a $2 million lottery prize would be divided among five people, which was answered correctly ($400,000) by only 56% of respondents. More shockingly, a basic question on compound interest on a savings account over two years was correctly answered by only 18% of respondents, with most incorrect responses failing to consider the compounding effect. This shows that even older, wealthier Americans, close to retirement, have issues with basic mathematics, let alone complex financial decisions. Overall, quantitative literacy, an umbrella construct encompassing numeracy, has been shown to be significantly related to financial behaviors (Nye & Hillyard, 2013).

Financial Knowledge

Financial knowledge is often assessed by several questions first proffered by Lusardi and Mitchell (2011), which are actually quite simple, yet frequently answered incorrectly. The 2015 NFCS survey included these six content-knowledge questions:

  1. Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow?
  2. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, how much would you be able to buy with the money in this account?
  3. If interest rates rise, what will typically happen to bond prices?
  4. Suppose you owe $1,000 on a loan and the interest rate you are charged is 20% per year compounded annually. If you didn’t pay anything off, at this interest rate, how many years would it take for the amount you owe to double?
  5. A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage, but the total interest paid over the life of the loan will be less.
  6. Buying a single company’s stock usually provides a safer return than a stock mutual fund.

Although the answer choices are all multiple choice or true/false, in the 2015 NFCS survey, only 28% answered Question 3 correctly, 33% answered Question 4 correctly, and 46% answered Question 6 correctly (Thripp, 2017). It appears that respondents cannot mentally compute compound interest, even when correct choices are as simple as “less than five years” with respect to Question 4, requiring no computation. For Millennials, financial knowledge is even worse than older groups (Mottola, 2014), and for all Americans, the micro and macro (e.g., Lusardi & Mitchell, 2014) effects are profoundly troubling.

Financial Behavior

Lusardi (2011) puts forth a literature review alongside an analysis of 2009 NFCS data. In part, her review notes the importance of financial literacy toward outcomes such as accumulating wealth, planning for retirement, taking on reasonable mortgages, and investing in equities via low-cost index funds. Then, an analysis of survey data reveals that about half of Americans report difficulties paying month-to-month bills, 51% have less than a three-month rainy day fund or no emergency savings at all, and a quarter have used high-cost borrowing such as payday loans. These are just a few of the many findings showing that Americans are living paycheck-to-paycheck with no safety net for unexpected events like job loss, a car breaking down, or unexpected illness (see also West & Mottola, 2016).

Gender differences. Mottola (2013) also used 2009 NFCS data to look at the gender gap with respect to credit card usage, finding that women tend to pay more interest and late fees, but suggesting that when controlling for demographics and perceived mathematical ability, the gender gap disappears. This shows that the gender gap in financial knowledge is multidimensional, relating to the gender pay gap and other inequities. It was seen in Chen and Volpe’s (2002) study that female college students have less motivation and confidence for learning about finance. These feelings of disempowerment may be related to mathematical stereotypes and may contribute to maladaptive financial behaviors such as aversion to saving (Garbinsky, Klesse, & Aaker, 2014).

Effectiveness of and Recommendations for Financial Education

When financial education works, it is often given “just-in-time,” such as requiring student loan applicants to complete relevant learning modules as a prerequisite for receiving their loan (Fernandes, Lynch, & Netemeyer, 2014). In addition, curriculum may be more easily remembered if based on benchmarks (“rules of thumb”) rather than complex decision-making criteria (Drexler, Fischer, & Schoar, 2014). This may result in improved financial decision-making subsequent to the course. At first glance, these suggestions may sound like common sense. However, in actuality most financial courses present complicated information in a lengthy format (e.g., a semester or school year), far in advance of when the insights are needed. Fernandes et al. (2014) conducted a sweeping meta-analysis of 201 financial education studies, which showed only 0.1% variance in financial behavior accounted for by financial education. In fact, the effects were weaker for those with low-income—who have the most to gain from increased financial capability, and any effects that were present generally dissipated within 20 months regardless of the length of the instructional intervention.

Although not refereed and sponsored by a corporation, Menard (2018) presents a cogent narrative about the history of American financial education and its ineffectiveness toward inciting behavioral change, citing leading researchers on financial education, psychology, and behavioral economics, while leveraging her past work on behavioral healthcare interventions (e.g., smoking cessation). Overall, despite doubling as a sales pitch for Questis, Menard (2018) points to financial coaching, just-in-time teaching, and behavioral interventions as alternatives to financial education courses that lack impact (e.g., Fernandes et al., 2014).

Hastings, Madrian, and Skimmyhorn (2013), in a narrative literature review exploring measurement of financial knowledge and the effectiveness of educational interventions. They note that while financial literacy is correlated with many beneficial financial behaviors, “the evidence is more limited and not as encouraging as one might expect” (p. 359) when it comes to financial education’s causal impact on financial outcomes. In fact, if we turn to Mandell’s prolific research (Mandell, 2006, 2009, 2012; Mandell & Klein, 2009), we see that high school students’ participation in lengthy financial courses failed to improve financial knowledge, let alone financial outcomes. Despite being a lifelong researcher and proponent of financial education, Mandell (2012) concedes that K–12 and college financial courses simply do not work, at least as presently conceived. This lends surprising credence to Willis’s long-held contention (2008, 2009, 2017) that financial education is useless and detrimental, standing in stark contrast to Lusardi’s (2011, 2017) conviction of its necessity. In fairness, a balanced conclusion is that financial education can be useful, but must be easily digestible and of immediate relevance (Drexler et al., 2014; Fernandes et al., 2014). Sadly, this is not a characteristic of the Jump$tart Coalition (2015) standards on which many financial courses are based.


Chen, H., & Volpe, R. P. (2002). Gender differences in personal financial literacy among college students. Financial Services Review, 11, 289–307.

de Bassa Scheresberg, C. (2013). Financial literacy and financial behavior among young adults: Evidence and implications. Numeracy, 6(2), 1–21.

Drexler, A., Fischer, G., & Schoar, A. (2014). Keeping it simple: Financial literacy and rules of thumb. American Economic Journal: Applied Economics, 6(2), 1–31.

Fernandes, D., Lynch, J. G., Jr., & Netemeyer, R. G. (2014). Financial literacy, financial education, and downstream financial behaviors. Management Science, 60, 1861–1883.

Garbinsky, E. N., Klesse, A.-K., & Aaker, J. (2014). Money in the bank: Feeling powerful increases savings. Journal of Consumer Research, 41, 610–623.

Hanna, S. D., Yuh, Y., & Chatterjee, S. (2012). The increasing financial obligations burden of US households: Who is affected? International Journal of Consumer Studies, 36, 588–594.

Hastings, J. S., Madrian, B. C., & Skimmyhorn, W. L. (2013). Financial literacy, financial education, and economic outcomes. Annual Review of Economics, 5, 347–373.

Jump$tart Coalition for Personal Financial Literacy. (2015). National standards in K–12 personal finance education, (4th ed.). Retrieved February 6, 2017, from

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Lusardi, A. (2012, February). Numeracy, financial literacy, and financial decision-making (Working Paper No. 17821). Washington, DC: National Bureau of Economic Research. Retrieved from

Lusardi, A. (2017, March 9). Remarks by Annamaria Lusardi, Academic Director of the Global Financial Literacy Excellence Center at the George Washington University School of Business. Meeting of the Security and Exchange Commission Investor Advisory Committee. Retrieved from

Lusardi, A., & Mitchell, O. S. (2007). Financial literacy and retirement preparedness: Evidence and implications for financial education. Business Economics, 10(1), 35–44.

Lusardi, A., & Mitchell, O. S. (2011). Financial literacy around the world: An overview. Journal of Pension Economics & Finance, 10, 497–508.

Lusardi, A., & Mitchell, O. S. (2014). The economic importance of financial literacy: Theory and evidence. Journal of Economic Literature, 52, 5–44.

Lusardi, A., Mitchell, O. S., & Curto, V. (2010). Financial literacy among the young. The Journal of Consumer Affairs, 44, 358–380.

Mandell, L. (2006, April). Financial literacy: If it’s so important, why isn’t it improving? (Issue Brief No. 2006-PB-08).

Mandell, L. (2009, January 4). The impact of financial education in high school and college on financial literacy and subsequent financial decision making. Paper presented at the meeting of the American Economic Association, San Francisco, CA.

Mandell, L. (2012). School-based financial education: Not ready for prime time. CFA Institute Research Foundation, 2012(3), 107–124.

Mandell, L., & Klein, L. S. (2009). The impact of financial literacy education on subsequent financial behavior. Journal of Financial Counseling and Planning, 20(1), 15–24.

Menard, M. B. (2018). So many courses, so little progress: Why financial education doesn’t work—and what does. Questis, Inc.

Mottola, G. R. (2013). In our best interest: Women, financial literacy and credit card behavior. Numeracy: Advancing Education in Quantitative Literacy, 6(2), 1–15.

Mottola, G. R. (2014, March). The financial capability of young adults—A generational view. Retrieved from

Mottola, G. R., & Kieffer, C. N. (2017). Understanding and using data from the National Financial Capability Study. Family and Consumer Sciences Research Journal, 46, 31–39.

Pinto, L. E. (2013). When politics trump evidence: Financial literacy education narratives following the global financial crisis. Journal of Education Policy, 28, 95–120.

Remund, D. L. (2010). Financial literacy explicated: The case for a clearer definition in an increasingly complex economy. The Journal of Consumer Affairs, 44, 276–295.

Thripp, R. X. (2007, April 4). Relationships between financial capability and educational attainment: An analysis of survey data from the 2015 National Financial Capability Study. Poster session presented at the University of Central Florida’s 14th Annual Graduate Research Forum, Orlando, FL. Retrieved from

Vitt, L. A., Anderson, C., Kent, J., Lyster, D. M., Siegenthaler, J. K., & Ward, J. (2000). Personal finance and the rush to competence: Financial literacy education in the U.S. Middleburg, VA: Fannie Mae Foundation.

West, S., & Mottola, G. R. (2016). A population on the brink: American renters, emergency savings, and financial fragility. Poverty & Public Policy, 8, 56–71.

Willis, L. E. (2008). Against financial-literacy education. Iowa Law Review94, 197–285.

Willis, L. E. (2009). Evidence and ideology in assessing the effectiveness of financial literacy education. San Diego Law Review46, 415–458.

Willis, L. E. (2017). The Consumer Financial Protection Bureau and the quest for consumer comprehension. The Russell Sage Foundation Journal of the Social Sciences, 3(1), 74–93.

Launching a new website on personal finance: Tippyfi

A few days ago, I started a new WordPress website called Tippyfi, with the tagline “making financial independence typical, one person at a time.” This will be a financial education website that I eventually hope to turn into a venture that provides financial advice in an innovative way. While I wrap up my Ph.D. in Education at University of Central Florida over the next 18 months, my goal is to write 100 really useful articles for the site (so far, I have three).

I have written quite a bit about personal finance here on, but I often write in a manner that is not accessible to the public. With Tippyfi, I am writing more accessible, edgy, image-laden pieces that develop, extend, and provide concrete examples for the financial benefit of my readers. Some of my articles will be “deep dives,” such as my new article on how credit card interest is actually calculated (hint: it’s unfavorable to the customer).

Join me over at Tippyfi as I start this new journey.

Graph of typical version of timing the market where people wait for a bigger drop, the market goes up a lot, the investor gives in and buys high, and then the market dips and the investor sells in a panic

Tax-Exempt Retirement Contributions and the Bucket Analogy

Here, I am continuing my prior post and other writings. Even though I am financially competent, tax-exempt retirement accounts are complex and I have only just discovered that Roth 401(k)s, which have only been available since 2006, actually have different contribution limits from Roth individual retirement accounts (IRAs; which have been available since 1997). Before, I had incorrectly thought that the combined limits between the two were $5500. Actually, the limit for a Roth IRA is $5500 per year (under Age 50) and for a Roth 401(k), an additional $18,000 (under Age 50; increasing to $18,500 in 2018). For Americans Age 50 and above, the limits are $6500 and $24,000 (the latter increases to $24,500 in 2018), respectively. Although I work for a university on a stipend (not fellowship) consisting of earned income via an assistantship (graduate teaching associate), I did not discover until recently I can contribute to a 403(b), the non-profit equivalent of a 401(k), in addition to a Roth IRA.

For the uninitiated, Roth accounts require you to have earned income for which you pay income tax now, but in retirement (above Age 59.5), all capital gains taxes are waived. There are also a few other situations such as medical expenses, education expenses, and first-time home-buying that allow you to make withdraws with waived capital gains taxes before Age 59.5. Depending on your tax bracket when the withdraws are made, under the new 2018 tax laws, your capital gains tax (which would be long-term due to investments being held over one year) could be 0%, 15%, or 20% depending on your income, but most likely 15%.

Roth 401(k)s can only be contributed to via employee contributions, which come out of your paycheck. Notably, your contribution is tax-exempt while any employer matching funds are tax-deferred like with a traditional 401(k). Employers usually have retirement programs with companies such as Fidelity whereby employees can pick a percentage of their pay to contribute. Roth accounts are especially applicable to low-income workers (i.e., in the 12% tax bracket) because they might be in a higher tax bracket at Age 59.5+, so tax exemption benefits them more. However, even for those with higher incomes, capital gains can far outstrip the initial contribution over many decades. Furthermore, anyone who has cashed out a U.S. savings bond knows the IRS gives no consideration to inflation when calculating the unearned interest income derived forthwith. Monetary inflation is also not considered for capital gains, which is a reason tax-exempt accounts are especially valuable.

Roth IRAs can only be contributed to via a person with earned income setting up one on his/her own, such as with Vanguard. Employers cannot offer Roth IRAs. Those with earned income can contribute up to $5500 per year to Roth IRAs, tax exempt, in addition to contributing up to $18,000 to a Roth 401(k) if their employer offers one.

Both traditional and Roth retirement accounts are wrappers for other types of investments. You could put your money in a money market account or certificate of deposit, bonds, or equities. Over long time periods (e.g., 15+ years), stocks are the best of these three types of investments. You can change how your retirement fund is invested at any time. Many financial advisers advocate for putting most of your money in an index fund of the S&P 500 or whole U.S. stock market while young, with a transition toward bonds as you near retirement, which offer less risk of loss but less potential for gains.

Sadly, both traditional and Roth retirement accounts grossly favor the wealthy and well-informed, perpetuating wealth inequality. Most Americans cannot being to approach the $18,000 annual limits on 401(k) contributions. Many do not even have an emergency fund. Wages are too low and expenses too high for them to contribute anywhere near $5500 per year to an IRA, as well. Nonetheless, every year that goes by is a missed opportunity to contribute, because there is no “catching up” on prior years’ annual contribution limits (besides being allowed to contribute for a prior year up until tax day—even after you have filed your taxes for Roth IRAs).

The ideal way to build wealth would be to contribute annually to your IRA as follows, and to your 401(k) too if you have the funds available:

Full annual contributions

However, even financially savvy Americans do not typically have enough money available to put $5500 in their IRAs nor $18,000 in their 401(k)s per year. If they are above-average, their contributions might look like this:

Varying partial annual contributions

However, the rules to withdraw retirement monies are complex and fraught with taxes and penalties. Most Americans cannot say with assuredness that they won’t “need” thousands of dollars until Age 59.5+. Contributing to a retirement account only to cash it out a few years later is common, often with penalties. Even without penalties, such behavior harshly perpetuates wealth inequality because there is no way to put the piggy bank back together after hammering it open (i.e., one cannot withdraw money and then make up for this later, and taking a loan from your retirement account comes with unsavory fees). Consequently, the statistical mode for American retirement contributions is as follows:

No annual contributions

Stocks go up and down. When we look at this S&P 500 chart from Wikipedia, it is clear that one could invest at a market peak and be upside-down for many years:

66-year S&P 500 chart

However, being invested over a long duration of time results in a near-guarantee of returns that exceed money market accounts, certificates of deposits, or bonds. Without thinking about tax-advantaged retirement accounts, one would think that late-bloomers to retirement saving can simply catch up by putting in a lot of money now. However, the annual contribution limits for these accounts, shown through the imagery of buckets, prevent late bloomers from catching up. Although one can contribute the maximum per year starting now, there is no way to go back and contribute for prior years—even at current market levels. Therefore, the typical American suffers the double whammy of missing out on tax-exempt or tax-deferred retirement savings and market gains. This situation is insufferable.

When you retire the chances are good that you will suddenly be receiving far less income than when you were working. If you apply for a reverse mortgage you can fix that problem by borrowing cash from your home’s equity. One reason such a loan is so popular is the lack of a monthly bill. If you were to apply for a traditional home loan you would increase your monthly bills by one. However, with a reverse-mortgage you can repay the loan long after you borrow the money. The only major stipulation is that you cannot move out of the home during the loan period. If you do so the balance must be repaid in full within a short period of time. Alternatively, the balance can be taken out of the sale price if the home is sold after you vacate it.

Updated 2018-01-30 to note graduate assistants can contribute to a 403(b) and to note $500 increase to 401(k) annual contribution limits in 2018.