how to explain to a hard headed 18 year old

[jIM_Ohio]

Originally Posted by jIM_Ohio

I would givwe two examples. One is compounding and one is taxes.

Two people, both age 18 are presented with choices. Person A contributes $5000 per year to 401k and gets a $2500 match, Person B waits 10 years and does the same for 20 years.

At age 48, which one has more money? Person A which invested $50,000 and had it invested for 30 years, or Person B which invested $100,000 for 20 years.

Answer- it's not even close. Person A will have DOUBLE what p[erson B does with investing 50% less. I have a spreadsheet I can plug numbers in, but not on this PC.

Taxes- sane situation, I would point out that a salary of 25k investing $5000 pre-tax saves around $750 in taxes now, so it's only about $190 being lost per month, maybe $150 depending on state.

I have my spreadsheets now...

here are numbers
I used a 7% return in both examples.

person A puts in $5000 of a 25k salary (25k is $12.50/hr for 2000 hours) with a 50% match ($2500). At age 28 person A has $126k in 401k from $50,000 in contributions (another $25000 contributed from employer).

Person B at age 28 has nothing.
Person A without contributing another dime has $490k at age 48 and clears $1 M around age 59.

Person B starts 401k with $5000 contributions and $2500 match at age 28. They continue for 20 years (age 48). At age 48 they have 360k. They invested $100k to get a $50k match and still have $130k less than person A.

Summary age 48:
Person A contributed $50,000 and has $490k- nearly a 10X return (1000%).
Person B contributed $100,000 and has $360k- a 3.6X return.

The biggest factor a person has to their return is giving themselves TIME.

If person A kept up the $5000 contributions thru age 48 (with same 50% match) they would have 819k at age 48 on $150k of contributions.

Once a person is in the habit of saving, good things happen.


TAXES:

Have your daughter ask any of the co-workers to give her tax advice and tell her what everything is on the paycheck- the percentages and what the different things are (FICA-medicare-State tax-Federal tax) and how each are calculated. Ask her which of those the employer matches (medicare and FICA/SS)

25k salary
6.2% SS/FICA=$1550
1.45% medicare=$362.50
Fed tax (assuming single, no exemption can be claimed)- $3332.50 (math is [$25,000-8,350]*15%+$835)
State tax (Ohio would be $1114.25).

Take home is $18,640.75 in above example with nearly $7000 paid in taxes. This is $1553/month

Put $5000 into 401k (20% of above income)
FICA is still $1550
medicare is still $362.50
$5000 is put into 401k
Fed tax is $2582.50 (math is [$20,000-8,350]*15%+$835).
(**401k cost $5000 and saved $800 in taxes**)
Ohio Tax would be $928.75 ($200 savings)

Yearly take home is $14576

Take home would be $1215/month.

$5000 is $400/month going in but only costs $300/month in take home because of taxes.

Add in that the $2500 match is there and she has more money, it's just in a tax shelter.


If she needed more incentive, explain how savings needs to be a habit and LBYM needs to be a habit. Create the habit with a small percentage (maybe 6-10%) and go from there.

[simpletron]

if she won't listen to the logical arguements(i like jim's the best ^) then go with a old fashion bribe. offer to cover her losses for the first year or two. losses would means she loses more than she contributed then you'll make up the difference aka she puts in 100, the match is 50 and the end value is 90 then you'll paid her 10. if her company has a good match then more than likely your daughter won't lose more than the match even in 100% stocks over the first year or two. so she can't lose money(probably will make it), starts build a habit of saving/investing, and it is little risk to you, assuming the company has a good match.

how little is the risk you might ask. I opened another international fund last november in my 401k. the fund is down 58% since I started investing in it. I have contributed 2604.74 and the current market value is 1738.08. if your daughter had a 50% match and had the same performance then you would owe her nothing because she would have still made $1.59.

[jIM_Ohio]

Originally Posted by simpletron

if she won't listen to the logical arguements(i like jim's the best ^) then go with a old fashion bribe. offer to cover her losses for the first year or two. losses would means she loses more than she contributed then you'll make up the difference aka she puts in 100, the match is 50 and the end value is 90 then you'll paid her 10. if her company has a good match then more than likely your daughter won't lose more than the match even in 100% stocks over the first year or two. so she can't lose money(probably will make it), starts build a habit of saving/investing, and it is little risk to you, assuming the company has a good match.

how little is the risk you might ask. I opened another international fund last november in my 401k. the fund is down 58% since I started investing in it. I have contributed 2604.74 and the current market value is 1738.08. if your daughter had a 50% match and had the same performance then you would owe her nothing because she would have still made $1.59.

If match is 50%, a 33% loss would be break even.

[simpletron]

there is dollar cost averaging at work here. I didn't invest all of the money in november, but in fairly equal amounts every two weeks for the past year. obviously the money I invested 1.5 weeks ago is not down 33%(down .5%), but the money invested 1 year ago is down over 50%.

2604.74*.66666666= 1736.49

added:

there are a reasons to only to do it for the first year or two:
1. because of dollar cost averaging and the relatively short time it is unlikely for losses to over power a good match.
2. you only need to get her started, once she is off and running, she probably continue on her own.
3. to get her started, you need to counteract her fear of losing money like her friends. in this case she can't lose money.

basically it is just a dirty trick to play, but it will probably work if logic doesn't. my fear with this plan is in the unlikely event she does lose more than the match, it would only comfirm her fear and she would likely be turned away of investing for an extended period of time. but I really doubt the stock market will fall another 50% or even 33%.

[irmanator]

wow this took off, i will continue to work with her a little at a time. but who knows i never saw such a stubborn child!!!

[mrpaseo]

I agree with the bribe approach, of course after all explanations. What you are doing with the bribe is giving her a fish, if you educate her you are teaching her to fish.

Here is what I suggest, if she still does not understand, then tell her you will pay her what she loses per pay period. It seems to me that she is worried about the money that she is losing out of pocket (Being 18 years old is all I am going on here). If her max 401k contribution is 75 dollars per month, offer to give her that money on her payday so she is not out any money. I would agree to do this for 12 months. After the 12 months you will have hard evidence to explain the benefits of the 401k.

During that year, she must agree to read what you tell her to, a carefully chosen book, or maybe a weekly sit down in front of this forum with threads that you chose. Maybe you can have a weekly discussion with her and any questions that come up, the two of you can post them and then readdress them the following week.

I would do all this in a contract that she must sign. If she defaults then she owes you the money back. Don't make it to painful, I would put the particulars such as not more than two hours per week tied up with this arrangement (Unless a mutual agreement), it will not be during her friend’s time, and there must be a mutual agreement to change a scheduled sit down (Assuming you go with the forums idea).

If you go with the book idea, you should schedule a required sit down time let’s say weekly or fortnight. You too must read the book. During this sit down you both discuss the topics in the chapters that you read. So, let's assume one chapter per week, you both read it, you both come together and discuss the material, and you figure out how it applies to your finances (At your age/position in life) and at her age (Just starting out). This will show her how the investments affect you and your current position and how much easier life would be if she started saving/investing now.

Ray

[prosper]

Originally Posted by irmanator

that it is in her best interest to sign up for 401k even though everyone at her job is complaining about what they are loseing? I have tried everything i can think of but she is not listening because, you know mom is stupid and her young friends are so much smarter.

I know how you feel. This actually applies to adults also. I have found out that sometimes it take a trusted third party to reiterate your thoughts in order for them to sink through to the intended person. My younger brother believes his college friends over me all the time. The latest subject that we have debated to date:full time college students DO NOT have to pay taxes. So far, i'm 56-0 against his friends.

[Investing First Steps]

Numbers don't mean anything to people who find comfort in spending instead of saving. People become very irrational. I don't really believe the stock market will do very well for a while to come but:

1.) Very few plans force you to invest solely in stocks.
2.) If you're getting any kind of match you're out of your mind not to take it. Even if you have to put the money in something you see as sub-optimal, it's hard to lose 33% if don't jump in all at once. (Even the 40% downturn we've seen recently was from very top to very bottom, so to have experienced all of that you would have had to put in at the top and take out at the bottom)

[Exile]

I used to be a strong advocate of 401(k)'s, but now I'm not so sure. I am a retiree who contributed regularly to this kind of plan while I was employed. But thanks to the meltdown, I've lost almost all the gains that I earned since I stopped working. (Fortunately, my principal is still intact) I'm still in the program and have redirected my balance from riskier investments into a fund with a "guaranteed interest rate" fund, which is supposedly safe but it's not FDIC insured. If and when bank IRA CD rates increase by another percentage point, I will transfer my funds there and get out of "securities" altogether.

Unless daughter's employer has a 401(k) plan that is matching and offers a bank CD plan as an investment option, I would advise her to open an IRA instead and stay away from 401(k)'s until the market stabilizes and is past the danger of a depression.

[mrpaseo]

To echo what Exile offered, I fully agree with contributing only up to the match, then I would highly recommend a ROTH IRA for the remaining retirement contribution. (Eventually moving into a diverse portfolio of ROTH IRAs)

Ray

[jIM_Ohio]

Originally Posted by Exile

I used to be a strong advocate of 401(k)'s, but now I'm not so sure. I am a retiree who contributed regularly to this kind of plan while I was employed. But thanks to the meltdown, I've lost almost all the gains that I earned since I stopped working. (Fortunately, my principal is still intact) I'm still in the program and have redirected my balance from riskier investments into a fund with a "guaranteed interest rate" fund, which is supposedly safe but it's not FDIC insured. If and when bank IRA CD rates increase by another percentage point, I will transfer my funds there and get out of "securities" altogether.

Unless daughter's employer has a 401(k) plan that is matching and offers a bank CD plan as an investment option, I would advise her to open an IRA instead and stay away from 401(k)'s until the market stabilizes and is past the danger of a depression.

Anyone which follows this advice is a fool in my eyes. Anyone which agrees shares the same sentiment from me.

This is buy high sell low. Terrible recipe for success.

If a person is retired, they need to have an asset allocation geared for income (around 30-60 percent bonds). If a 40 percent loss is the only gains a person had, they did not have a lot to start with.

Most people will have 400 percent or 1000 percent gains in retirement portfolios. I contribute 20k per year for 30 years (600k), I expect around 4X that (2.4 M) in retirement. Losing 40 percent would hardly wipe out all the gains for someone which invested wisely their whole career.

A person could use an IRA and a 401k for the same investment. It's not the 401k which is the problem, it's how a person chose to invest the money.

401k is better because it has a 16,500 contribution limit, IRA is 5000.

[disneysteve]

I agree, Jim. If a retiree lost 40% of gains in the recent downturn, that suggests to me that the portfolio was much too aggressive for a retiree.

Waiting until the market goes back up before buying in makes no sense. Again, that's Buy High, Sell Low. Ironinc how people are willing to buy overpriced shares when the market is hot but aren't willing to buy those very same shares when they are on sale for 40% off. That would be like saying, "Oh, Best Buy has that computer I want on sale this week for $1,500 but I think I'll wait until next week to buy it when it is back to $2,500.

[Exile]

Originally Posted by jIM_Ohio

Anyone which follows this advice is a fool in my eyes. Anyone which agrees shares the same sentiment from me.

This is buy high sell low.

What planet are YOU on jIM-Ohio? (And BTW, disneysteve, I'm surprised at you too.) You may have not noticed but the American economy is in a whole new universe now. The concept of defined contributions (401(k)'s) for workers, which was questionable to begin with, instead of defined benefits (pensions) is now a disaster for millions who have contributed to these plans. What you're proposing is buy low and sell lower. The economy and market are not likely to improve for a LONG time to come, the best efforts of Obama notwithstanding. It's the 1930's all over again.

No matter how young a person is if (s)he starts investing now, (s)he will still lose his/ her shirt for many years before seeing the light of day, if ever. If you still believe in dollar cost averaging after all that's happened in the past several months, you're the biggest fool of all.

Just to see how worthless securities have become as an investment, take a look at the investment performance of plans in Mass Mutual(my 401(k group of funds). Most of them have lost over 40%--80% in value. Then tell me what a wonderful "opportunity" the stock market still is and will continue to be.

[jIM_Ohio]

Originally Posted by Exile

What planet are YOU on jIM-Ohio? (And BTW, disneysteve, I'm surprised at you too.) You may have not noticed but the American economy is in a whole new universe now. The concept of defined contributions (401(k)'s) for workers, which was questionable to begin with, instead of defined benefits (pensions) is now a disaster for millions who have contributed to these plans. What you're proposing is buy low and sell lower. The economy and market are not likely to improve for a LONG time to come, the best efforts of Obama notwithstanding. It's the 1930's all over again.

No matter how young a person is if (s)he starts investing now, (s)he will still lose his/ her shirt for many years before seeing the light of day, if ever. If you still believe in dollar cost averaging after all that's happened in the past several months, you're the biggest fool of all.

Just to see how worthless securities have become as an investment, take a look at the investment performance of plans in Mass Mutual(my 401(k group of funds). Most of them have lost over 40%--80% in value. Then tell me what a wonderful "opportunity" the stock market still is and will continue to be.

I am on this planet, you apparently live in another world.

If a person has a 401k, my guess is they are still working and contributing- so losing 40 percent is par for the course. They do not need the money now, as they are working.

Above you suggested to use IRAs and not 401ks- its not like those are different. You neglect all tax deductions in your broad statement (401ks are bad) as well as the flexibility they provide over pensions (I can borrow from a 401k, I can retire early with a 401k, I can invest as aggressively as I want or as conservative as I want).

It's not that your advice was wrong, it's that your advice was bad and blatantly one sided.

This economy is no different than 2000-2002, 1991, 1987, 1970-1973 and similar with inflation, unemployment or a market crash. The stock market is only 1 indicator of things. I will profit from others panic, so feel free to keep spouting your funny view on things- its people like you which will let people like me make money.

[disneysteve]

Originally Posted by Exile

Unless daughter's employer has a 401(k) plan that is matching and offers a bank CD plan as an investment option, I would advise her to open an IRA instead and stay away from 401(k)'s until the market stabilizes and is past the danger of a depression.

This is what I wasn't agreeing with. There is no fundamental difference between a 401k and an IRA. Neither one represents a specific investment but rather is simply a type of account. You could have a 401k and an IRA with each invested in the exact same things, so saying someone should avoid a 401k and use an IRA instead doesn't really have meaning. What matters is how the money in those accounts is invested and allocated. Of course, there are also tax and distribution issues that differ between them.

Also, you are sharing your 401k experience as a current retiree and using that experience to suggest what an 18-year-old worker should do today. Those are two very different life situations and they warrant very different investment advice.

I do agree with you that 401k plans are not the wonderful retirement solutions they were touted as. Traditional pensions were certainly far better for the average worker, but we can't control that. We've got to work with what we've got. So yes, I continue to believe that people, especially young people 30 or more years from retirement, should be contributing to employer-sponsored retirement plans and being aggressive with their allocations. None of us knows what the market will do or when it will recover, but I do believe it will recover and I don't believe in market timing. There have been numerous posts here and elsewhere from folks who are waiting for the market to stabilize or start going up again before they invest. I think, in most cases, that is not a good strategy.

[Investing First Steps]

I think many cases can be made for this being an unusual economic circumstance where you may not see "classic" stock market returns for some time to come however I'd make two important points:

1.) One of the reasons investing in a retirement account is often effective is because it works out to "forced" dollar cost averaging. We all know that and important part of the mechanism of dollar cost averaging is to make sure I buy more when prices are low and less when prices are high. So if you stop investing because the market has gone down, then you are essentially locking in the bad part and avoiding the good.

2.) One of the reasons the economy will be "bad" for the coming years is likely to be inflation. If there is rampant inflation for a period in the future, you will not be best served by having your money in cash. Stocks may not be the optimal hedge against inflation, but they are better than fixed return vehicles like CDs. Especially when ultra-low interest rates will be part of that inflationary force.

[cptacek]

The biggest problem is that some people think:
401(k) = Dow or S&P 500
and IRA = bank CD
instead of thinking of them as different tax buckets.