Henry Hazlitt Got This Wrong

One of the best books on economics of all time is Henry Hazlitt’s Economics in One Lesson.  Many libertarians will say that they got their start with Hazlitt, or at least their start in learning economics.

I recently released a book titled Free Market Economics Made Easy.  I am not trying to compete with Hazlitt.  If anything, I think my book can be a good supplement.

With that said, there is something that Hazlitt gets wrong in his book.  Chapter XXIV (24) is titled “The Assault on Saving”.  With Keynesian economics still dominating today, his chapter is as timely as ever.  Unfortunately, despite the chapter title, he makes a big error when writing about savings.

Hazlitt compares two individuals – one who saves a good portion of his income (Benjamin) versus one who consumes all of his income.  In talking about the saver, Hazlitt states: “But let us see what Benjamin actually does with this other $25,000.  He does not let it pile up in his pocketbook, his bureau drawers, or in his safe.  He either deposits it in a bank or he invests it.  If he puts it either into a commercial or a savings bank, the bank either lends it to going businesses on short term for working capital, or uses it to buy securities.  In other words, Benjamin invests his money either directly or indirectly.”

We could probably get on the subject of fractional reserve banking based on the above citation.  But it gets worse than this.

Hazlitt continues, “Mere hoarding of hand-to-hand money, if it takes place irrationally, causelessly, and on a large scale, is in most economic situations harmful.  But this sort of hoarding is extremely rare.”

Hazlitt is flat out wrong on this.  I address this with a chapter specifically on hoarding money in my book.  I argue that hoarding money is not at all harmful to the economy.  If it is harmful to anyone at all, it is the hoarder.

Let’s use an example.  If you knit a sweater and then sell that sweater for $25, then you have produced a product that is worth $25 to someone.  For the sake of simplicity, we will ignore the cost of the yarn used to knit the sweater.

Now let’s say that you take the $25 that you earned through your labor and you bury it in your backyard.  Better yet, let’s say you take the $25 in cash and throw it in your fireplace to be burned.  Is this bad for the economy?

It is bad for you because you now have $25 less.  You expended your labor to make a sweater and you were entitled to your $25 to consume on something else.  That $25 represented your redemption for the value you produced with the sweater.

The fact that you burned your 25 dollars does not directly impact the person who purchased the sweater.  The buyer deemed himself better off with a sweater than the $25, so it shouldn’t make any difference to him what you do with the money.

But you produced a 25 dollar value for society and didn’t get anything in return.  You essentially gave a sweater to society.  You could have consumed something in return, but you burned your money instead.

You could have given the sweater away, which would have benefited one person.  Instead, you essentially benefited the entire economy by $25 at your own expense.  Obviously, in a large economy, this is a drop in the ocean.  But it has the impact of bringing down consumer prices for everybody else, even if by an immeasurable tiny fraction of a penny.

So while Hazlitt is correct that capital investment is important to grow an economy, it doesn’t mean that hoarding money is harmful.  Hoarding money means that people are not redeeming things despite having contributed to the economy.  They are giving their labor or their things to others, and they are not getting an equal amount back.

I was surprised to stumble across this mistake by Hazlitt.  I still wouldn’t hesitate to recommend his book to anyone though.  In his day, he was a shining light in a world of statist thought.

If you want to read my take on free market economics, you can get the e-book for free if you are reading this before Sunday, April 30, 2017 at 11:59 PM.  Since it is currently free, you can hoard your money and help the economy with consumer price deflation.

My book can benefit those with little knowledge of economics, but I also believe it will help clear up some thinking even for those who are more hardcore libertarians and consider themselves to be well educated in the issues, especially economics.

If you missed the book promotional or you want to order the paperback, I still encourage you to pick up a copy.  However, I won’t claim you are helping the economy by spending your money.

There is Such a Thing as a Free Lunch

There is a joke about two economists walking along a crowded street.  The one economist says to the other, “Hey, look, there’s 20 bucks on the sidewalk.”  The second economist keeps walking and doesn’t even look down.  He responds, “You know that’s impossible because if there were 20 bucks on the ground, somebody would have picked it up already.”

While libertarians like to say that there ain’t no such thing as a free lunch (TANSTAAFL), sometimes there really are free lunches.  When the government promotes something, it is done at the expense of others through the use of force.

But there are win-win situations where everyone can benefit.  That is what the free market is all about.  In this case, I present to you a win-win situation, and it is like a free lunch for you.

I recently released my book titled Free Market Economics Made Easy.  From now until Sunday, April 30, 2017, you can get the electronic version for free.

You get a free e-book, and I get “sales”.  Even though I don’t make any royalties off of the free book “sales”, they still help the ranking on Amazon.  So you are doing me a favor if you accept this free e-book.  It’s win-win.  It’s not like the government where a few people win and most everybody else loses.

If you are reading this after April 30, 2017, you can still buy the e-book for just $3.49.  And if you are someone who needs to hold a book in your hands, then you can order the paperback for $7.99.

Take your free lunch.  I didn’t have to force anybody to cough up money so that you can have your free e-book.

Free Kindle Book – Free Market Economics

I recently released my new book titled Free Market Economics Made Easy.


The book has 35 relatively short chapters, and each chapter stands on its own.  I purposely do not discuss political parties, and I even mostly avoid political figures.  The book shows why peaceful and voluntary cooperation leads to human flourishing and why government interference distorts this process.

This book was written so that somebody with a minimal knowledge of economics could still understand it.  A mature high school student or homeschooler could benefit.  With that said, I think many libertarians and libertarian-leaning people will benefit greatly from this book.  My hope is that it will clarify your own thinking and also help you to articulate the message of liberty and free markets to others.

From Wednesday, April 26, 2017 until Sunday, April 30, 2017, you can download the Kindle edition for free.  My hope is that readers of my blog will take advantage of this opportunity.  If you read the book and enjoy it, please leave a review on Amazon.

If you are reading this post after the promotional period has expired, you can still download the Kindle edition for just $3.49.  And if you are someone who needs to hold a book in your hands, you can purchase a paperback edition for $7.99.

Are American CEOs Overpaid?

We hear complaints from the political left about inequality and wage gaps.  One frequent complaint is that CEOs and other top executives of major companies are making excessive amounts of money.  You may hear something such as, “A CEO shouldn’t be making 1,000 times the salary of a minimum wage worker.”

A standard response from some Republicans and libertarians is that they are earning that amount because that is what their value has been deemed to be by the open market.

This response is mostly true for founders of companies who earn tens of millions of dollars or more.  I think even many on the political left will agree to a certain extent that Bill Gates and Steve Jobs deserved to be well compensated for providing value to consumers.

The problem is that there are obviously some fools who run some of the top companies in the United States.  It is difficult to see how they can be making millions of dollars per year making stupid decision.

Take the recent incident involving United Airlines when a passenger was bloodied up after refusing to leave the airplane because the airline wanted four of its employees on the flight instead.  When nobody was willing to accept the $800 incentive to take another flight the next day, the airline bumped people off (probably illegally because it wasn’t a case of overbooking) instead of raising its offer.

The CEOs response was one of justification and word games.  He used the term “re-accommodate”  to describe forcing the passenger off the plane.  He thought this propaganda would somehow help ease the situation.  The guy is a total idiot who is being paid millions of dollars.  He is completely out of touch with reality.

He could have consulted me before he put out his stupid statements, and I could have told him not to send them out.

He should have simply stated, “We apologize for the situation that recently took place.  We are doing a full investigation of the situation, and we will revise our policies as necessary to make sure such an incident does not happen again in the future.”

But the idiot multi-millionaire CEO (likely put in place by idiot multi-millionaire board members of the company) doesn’t see it.

Therefore, there is obviously something wrong with the standard response that these executives are just being paid their market value.  You could have paid many people a small fraction of what the United CEO is paid to not put out an idiot statement like he did.

The problem here is that we simply do not have a fully functioning free market.  There are free market elements where providing value to customers can make you rich.  Again, Steve Jobs and Bill Gates brought value to hundreds of millions of people.  (This is ignoring that Bill Gates likely used government copyright and other laws to his advantage.)  But there are many elements of government interference that distort things, including executive pay.

In the case of United, the airline industry is heavily regulated.  Foreign companies are not allowed to offer domestic flights within the United State.  If Singapore Airlines and Emirates were flying within the U.S., there probably would no longer be a United Airlines.

We see the idiot bankers who helped contribute to the financial crisis that blew up in 2008.  But maybe they aren’t that idiotic for the simple fact that they secured bailouts after it happened.

And that brings me to one very important point.  Because government – particularly the U.S. government – so heavily regulates business, CEOs and other executives are often selected more for their political abilities than their abilities to provide value to consumers (and hence shareholders).

Also, for these publicly traded companies, there are also major distortions due to the tax code.  In a true free market, companies would seek to pay out dividends to shareholders instead of trying to get big capital gains.  The CEOs are often rewarded with shares of stocks that get inflated by central bank inflation and stock buyback programs.

These are just a few points.  There are thousands of laws and regulations and taxes that distort the market economy and inflate the pay of CEOs.  And not only do these things inflate their pay, but they also put people in these positions that shouldn’t be there.  It is people who are good at politics who get these positions, unless they were a founder.  In some ways, it makes sense for companies to put political figures in these positions, as political favors will be more profitable than trying extra hard to satisfy consumers.  And if anything, getting political figures is important for defensive purposes just to make sure the government doesn’t pass laws against the company or industry.

In conclusion, the political left actually has a point that many CEOs and top executives are overpaid.  The problem is that their solutions are often the exact opposite of what is needed.  The answer isn’t for more government regulation. The answer is to free up the marketplace to make these executives and their companies more accountable to consumers.

In a true free market, the only way for a company to survive in the long run is to provide great value for consumers.  If a CEO can concentrate on this and provide it, then it will benefit the shareholders in the long run.  Until this situation of a real free market arises, we really don’t know what these CEO positions should be worth.

The Overrated Mortgage Interest Deduction

As I write this, another tax filing season just finished up.  I recently spoke with someone who does some work on the side helping people prepare their tax filings.  Most of her clients are not simply filing a 1040EZ form or even a simple 1040 form.  They tend to be investors, or small business owners, or have rental real estate, or some combination.  In other words, her clients aren’t generally people making a low income.

I asked her specifically about the mortgage interest deduction.  She said that a sizable majority of her clients do not qualify for the deduction.

While we hear about the great benefits of being able to deduct the mortgage interest on your primary residence, it is highly overrated for most people.  The fact is that the standard deduction for 2016 was $6,300 for singles and $12,600 for married couples filing jointly.  For a married couple, you will need a lot of mortgage interest and other deductions to qualify.

She said that a few people have mistakenly believed that you can deduct your mortgage payments.  But when you make a mortgage payment, a portion is going to interest and a portion is going to pay down the principal.  In many cases, people also have taxes and insurance included as part of their mortgage payment.  They may also pay private mortgage insurance (PMI).  You can only deduct the interest portion.

For somebody who just bought a house, the interest portion will make up a large portion of the mortgage at the beginning of the loan.  As time goes on with each payment, the amount going to interest decreases each month, while the amount going towards principal increases.  She said that many of her clients had owned their house for several years and therefore did not pay nearly as much in interest as when they first bought.

This is a generalization, but people who own a house with a significant mortgage tend to be married.  To qualify for the mortgage interest deduction as a married couple, the interest alone, combined with other deductions, will have to exceed $12,600 to get any benefit.

The people who will mainly benefit from this deduction are those who live in areas with high housing prices and those who donate a lot of money.

If you have a married couple earning $100,000 per year and they donate $10,000 per year to their church, then they might easily get a tax benefit from their mortgage interest.

If you live in San Francisco or New York City (or any high-priced city in the U.S.), then you may benefit from the mortgage interest deduction if you have a large mortgage.  Of course, I would much rather live in a normal place and pay $200,000 for a house and not get the deduction than to live in a place where you pay $800,000 for the same-sized house and get the deduction.

Here is one other important thing to consider.  Let’s say that a married couple does have enough mortgage interest and charitable contributions in order to itemize.  They have $13,000 combined, which exceeds the $12,600 standard deduction.  If this couple is in the 25% tax bracket, then they will save a whopping $100.  The difference between itemizing and taking the standard deduction is $400 ($13,000 – $12,600).  But that is not a tax credit.  It is just a deduction.  At 25% of $400, congratulations on that great mortgage deduction that saved you $100 for the year.  I hope your $2,000 per month mortgage payment was worth it.

Of course, some people benefit far more than this.  But the reality is that it just does not benefit that many people.  And for those who do benefit, the actual dollar amount is usually far lower than they would estimate.

According to the Tax Foundation website, 30.1 percent of households chose to itemize their deductions in 2013.  But this doesn’t tell us how much they benefitted by itemizing.  Again, think about the $100 benefit from the example above.

You should never pay more for a house with the rationale that you can deduct the mortgage interest.  That is a terrible reason (justification) to buy an expensive house.  You should buy a house as a consumer good.  If you are buying a house for investment purposes to rent it out, then this situation doesn’t apply to you anyway, as rental real estate is handled separately and does not impact whether or not your itemize your deductions.

Buy a house because you think it is a good decision.  But I would suggest not factoring the mortgage interest deduction in this decision.

How Can the Fed Sell Mortgage-Backed Securities?

In the fall of 2008, the Federal Reserve started its policy of wild monetary inflation.  It became known as quantitative easing (QE).  We have gone through QE1, QE2, and QE3.  The last round (QE3) ended in October 2014.

The Fed somehow managed to approximately quintuple its balance sheet between 2008 and 2014 while keeping consumer price inflation relatively low.  Much of the newly created money went into bank excess reserves, which helped prevent price inflation.  If all of this new money had been multiplied through fractional reserve lending, we would have likely seen extraordinary consumer price inflation.

Long before QE3 ended, we heard from Bernanke and others that the Fed would one day sell off its assets to return to normal.  In other words, the Fed would return its balance sheet somewhere in the neighborhood of its early 2008 balance sheet, or at least significantly reduce it from where it is now.

It has taken the Fed several years now just to hike its federal funds rate target by 0.75%.  There seems to be no likelihood of a major selloff of the Fed’s balance sheet soon, but there has been a little bit more talk about it lately.

Here is the problem.  It is not possible for the Fed to return to its early 2008 balance sheet, or if it does, it will be meaningless.

Of course, it is basically impossible politically speaking because the asset boom we have seen, particularly in stocks, is likely largely based on the Fed’s easy money.  If the Fed engages in significant monetary deflation, the boom collapses.

But it might also literally be impossible for the Fed to reduce its balance sheet by over $3.5 trillion.  In 2008, the Fed began buying other assets aside from U.S. Treasuries.  It began buying mortgage-backed securities (MBS).  It was one portion of the many bank bailouts, as the Fed bought these MBS for their original value instead of the actual market value.

Many of these mortgages were in default with the crash in housing prices.  If you have a bunch of mortgages where the people aren’t paying and the collateral (the houses) are worth half as much, then the mortgages are worth a lot less than their original value.

Since 2008, the Fed has accumulated nearly $1.8 trillion in MBS, which far exceeds its total balance sheet prior to 2008.  The problem is that we don’t know what these MBS are actually worth.  If the Fed were to sell them on the open market, it would likely spike interest rates and severely damage the mortgage market.  And there is no way that the Fed could get $1.8 trillion back on these MBS.  We really have no idea what they are actually worth.

What if the Fed could only sell them all for $1 trillion?  That means that $800 billion would be vanishing into thin air.  Well, that is not exactly it.  The $800 billion was already created and essentially given to the banks as part of a bailout.  That newly created money is very hard to withdraw unless they somehow force the banks to buy back the mortgages at their original value.  But this would just cause bank failures again.

So the only way the Fed can reduce its balance sheet back to early 2008 levels is by writing down this amount.  It would be meaningless.  At this point, it is just numbers on a graph or in a spreadsheet.  The Fed could say that its $1.8 trillion in MBS is actually only worth $1 trillion and subtract $800 billion from its balance sheet, but it doesn’t change the situation.  That money was already created out of thin air and given to the banks for their bad debts.

The Fed can sell off its U.S. government debt (Treasuries) or let them mature without rolling them over, but that would only go so far.  Plus, this would eventually hurt the federal government’s ability to borrow at low interest rates.

In other words, there will be no significant reduction in the Fed’s balance sheet that means anything.  Maybe we will see a couple of hundred billion dollars.  But any sign of a recession or stock market crash and you can be sure that all bets are off.  If anything, the Fed would starting inflating again.

We may still see a recession even if the Fed does not do anything.  Since it hasn’t been inflating, its policy has been monetary stability for the last couple of years.  But that doesn’t change its previous policy of massive monetary inflation and all of the malinvestment that went with it.   At some point, it will be exposed.

I think we are more likely to see QE4 before we see any significant reduction in the Fed’s balance sheet.

CPI Falls in March 2017

The latest Consumer Price Inflation (CPI) numbers are out for March.  The CPI dropped 0.3% from the previous month.  The year-over-year CPI stands at 2.4%.

The more stable median CPI continues to be stable.  The year-over-year median CPI is up 2.5%.  This is the same figure over the last 6 months.

Overall, there is not much to get excited about in either direction.  It looked as if consumer prices were picking up, but March is a slight reversal.

Gold has been rising the last few weeks, but that likely has little to do with price inflation.  It is more of a reflection of Trump’s now reckless foreign policy.

The inflation numbers are not showing any significant trend in either direction.  This means that the Fed will not change its policies unless something else changes.  The Fed will continue to do mostly nothing except roll over maturing debt and occasionally raise its federal funds target rate by one quarter of one percent.  This will be more free money for the banks, as the Fed’s primary tool is paying interest to the banks on their reserves.

While the sentiment on stocks is mostly bullish, there are certainly warning signs out there.  We know stocks are going to fall hard at some point.  It is just a matter of when and how far.

It will be interesting to see what Trump does with the Fed.  If he gets a bill to audit the Fed on his desk, I think he will veto it at this point.  He has done a 180 degree turn on almost everything else, so why not the Fed?  There is already talk that maybe he will just keep Janet Yellen as Fed chair.

If everything is still calm, economically speaking, in late 2017, then I think Trump may just keep her so as not to rattle anything.  If things get ugly before then, then Trump can put blame on Yellen and replace her with the next establishment hack.

The economy overall right now is just kind of sitting there.  There is not much growth.  There is little in the way of really good news or really bad news.  Everything is just puttering along.  Meanwhile, the federal government keeps accumulating more debt and spending huge amounts of money.  Our living standards are far worse off than they should be because of government spending and regulation.

We’ll keep an eye on price inflation to see if there are any significant shifts.  For now, there doesn’t seem to be much happening, but we know things can change quickly.  If I had to bet right now, I think we will see an economic slowdown/ recession before we see a significant increase in consumer price inflation.

What You Can Learn From the Internet Retirement Police

There is a very small percentage of the population that belongs to the financial independence/ early retirement community.  Some might call it a movement.  I don’t know if such a movement exists outside of the United States, but I would expect it to be smaller.

While there is no set definition, we aren’t really talking about somebody retiring at the age of 60 instead of 65.  There are some people in their 30’s who have claimed the mantle of early retirement.

But just as people in their 30’s and 40’s have claimed a status of early retirement, there are critics out there who say that many of these people aren’t actually retired.  These critics have been referred to as the Internet Retirement Police (IRP).

Mr. Money Mustache is one of the most famous leaders of the early retirement community.  His blog is very popular.  He wrote a post back in 2013 about the Internet Retirement Police.

The post is somewhat sarcastic in its own right, as Mr. Money Mustache is mocking the very people who are mocking him or those within the early retirement community.  He is basically saying that if you make any money from any kind of job or side business that the IRP will show up and say that you aren’t really retired.

I am not here to defend the entire IRP.  There are always people out there who will be critical of anything.  I am not trying to defend every criticism made against the early retirement community.

Still, I think that the IRP (maybe I am part of this group now) has some valid points that we can learn from.  It seems reasonable to be skeptical of somebody who claims (and probably brags) about early retirement yet is still making a lot of money from current work.

Here we get to a definition of “retirement”.  Mr. Money Mustaches states in his post: “Retired probably does not mean you sit at home watching TV, venturing out only for medication or a motorized-cart-aided round of golf.”  On this, I agree that retirement doesn’t mean you have to sit around and basically do nothing.

Still, I think some people are too loose with the term.

Mr. Money Mustache mockingly states: “It’s a shame we don’t have a better name for all this stuff we’re doing as Mustachians.  Retirement doesn’t sound right.  Financial independence comes closer.  Can we invent a new word for it?  How about Removed?”

He continues: “News Flash: the perfect word has already been invented.  Are you ready to hear it?  Here it is: Retired.”

He continues: “It’s perfect just as it is.  It’s just like ‘Financially Independent’, but it sounds more amazing and it uses 75% fewer syllables.”

The problem is – and this is where the IRP get it right – the term is simply not accurate in many cases.

Mr. Money Mustache then defines “retired” in his next paragraph: “‘Retired’ means you no longer have to work for money, and you are aware of this fact.  You can then proceed to do whatever you want, as long as you do it consciously and of your own accord.  If you meet this condition, and you feel retired, congratulations, you are.”

The problem is that it is not true for many people in their 30’s and 40’s who claim this status that they can afford to never work again.  They have the ability to tell their boss to shove it because they have enough money and a low enough standard of living that they could afford to live off of savings for five or more years.  But if someone is age 35 and ends up living to the age of 85, does he really have enough money to never earn another dollar (not counting the earnings from his investments) for another 50 years?

Many in the early retirement community advocate the 4% rule.  Your annual expenses should equal 4% of your total savings/ investments for you to retire.  Take what you spend in a year and multiply it by 25.  This is your early retirement figure.  If you spend $50,000 per year, then you need $1.25 million.

But we don’t really know this to be true.  We have no idea what the economy will be like over the next several decades.  What if the U.S. stock market ends up like the Japanese stock market of the last three decades?  If you invested in the Japanese market in 1989, you are still down by about half nearly three decades later.

And what if we have severe price inflation?  Are all of these early retirees invested heavily in gold and other inflation hedges?  What if there is double-digit price inflation at the same time as a down stock market?  Many people will be throwing their retirement plans out the window.

For Mr. Money Mustache, I really have no idea what his situation was when he “retired” and what it is now.  I know that his blog gets a lot of traffic and that he is making well into six figures with it (one 2016 story put his earnings at about $400,000 per year).  There is absolutely nothing wrong with this, and I think it is great that he can enjoy his life and do something he enjoys and is passionate about while also helping others.  With that said, I just don’t really like the word “retired”.

I prefer the term “financial independence” or “financially independent”, so I am one of the people that he is speaking to in his post from several years ago.  I don’t care if “financially independent” has more syllables because it is more accurate in most cases.

It is not about retiring in your 30’s or 40’s; it is about having freedom.

Mr. Money Mustache had the freedom to quit his cubicle job while in his 30’s and explore things he was passionate about.  His blog took off, and he is better off for it.  If his blog had gone nowhere, he probably would have found something else to do that he likes that could supplement his income.  Again, there is absolutely nothing wrong with this, but I do have a point of contention with the word retirement.

I really have no idea how much he had when he first “retired”, but I have my doubts that Mr. Money Mustache could have gone 50 plus years living on just his savings and investment income up until that point.

I think being financially independent is a worthy goal, and there is much to learn from others who strive (or have already achieved) this status.  Even if you could officially retire (never work for money again), I don’t know if it is a good goal anyway.  Are you really going to sit around and do leisure activities for the rest of your life starting in your 30’s?

Most multi-millionaire/ billionaire businessmen continue to work in some capacity even though they could easily retire.  They aren’t still in the game so that they can spend more money.  Maybe it is a game to accumulate more money, but it probably isn’t for consumption.

I don’t really believe that early retirement should be a goal.  If you have ambition, you are still going to want to achieve things.  Your goal should be financial independence so that you can pursue things that you are passionate about.

You can call me part of the Internet Retirement Police if you want, but I am calling out those who call themselves ” permanently retired” who really are not able to never work for money again.  If you only have 25 times your annual expenses saved up and you are going to live another 40 or 50 years, I don’t think you are officially retired.  You don’t know what your rate of return will be.  You don’t know what your expenses will be in the future.  You don’t know what tax rates will be.  You don’t know what inflation will be in the future.

We live in a great world where it is actually possible for a few people to officially retire at a very early age.  It is even better where people can achieve financial independence and seek work that they enjoy.  This was mostly not possible 100 years ago.  It certainly was not possible 1,000 years ago unless you were royalty.  Even then, it was mostly a miserable life.

In conclusion, I think definitions can matter.  I see many in the early retirement/ financial independence movement as smart people.  However, I don’t think most of them are actually permanently retired in their 30’s or 40’s.  There is nothing wrong with this, but they shouldn’t mislead people into believing that they could go on never working for money again.  That is why I prefer the term financial independence.

10 Reasons Not to Contribute to a 401k Plan

In a relatively free market with no federal income tax, a 401k plan would be meaningless.  The 401k plan is essentially a loophole in the tax code that allows you to contribute pre-tax dollars.  You can grow your money tax-free until you withdraw it.  In exchange for this tax benefit, the government and your employer maintain certain controls (rules) that you must follow.

There are good arguments to be made for contributing to a 401k plan.  These include tax deferment, a company match, and an easy way to contribute (payroll deduction).  This is not a list to instruct you to not contribute to a 401k plan.  These are just reasons on why you might consider not contributing.

Some of the reasons might be similar or overlap, but they are all legitimate reasons on why someone might not want to contribute to a traditional 401k plan, even if their company matches contributions.

Here are 10 reasons not to contribute to a 401k plan.

  1. If you are still employed with the employer that sponsors your 401k plan, then in most cases you cannot withdraw your money before age 59½.  If you really want your money, you will have to quit your job.  Therefore, a 401k is completely illiquid for most people.  I would rather have $20,000 in the bank than $25,000 sitting in a 401k plan that I can’t touch.
  2. If you no longer work for your employer that sponsors your plan, then you will still pay a 10% penalty (plus taxes) for a withdrawal if you are younger than 59½.
  3. Instead of contributing to a 401k plan, you could use that money to start a business or some kind of venture that would generate income.  Imagine if Bill Gates or Steve Jobs had taken the little money they had when they were young and put it into a retirement account instead of using it to start their businesses.
  4. Instead of contributing to a 401k plan, you could use that money to buy a house (either to live in or to rent out).  While there are pros and cons to buying real estate, some people would find themselves better off using any excess money to put into real estate.
  5. You are vulnerable to any changes in the law at any time.  Congress could pass a law that raises the age for withdrawal.  The government could require that you use a certain percentage to buy U.S. Treasuries.  The government could impose a wealth tax that would subject 401k investments to a special one-time tax (or more).  This, of course, would all be done in the name of helping the poor or helping the country in a time of need.
  6. To go along with number 5 above, there could be a change in the marginal income tax rates at any time.  The tax code changes at some point with almost every presidential administration.  If tax rates are 45% when you retire with your 401k, your tax deferral all of a sudden doesn’t seem that brilliant.
  7. You are usually forced into buying specific mutual funds in a 401k plan.  Perhaps you have a good plan where you can choose almost any mutual fund.  Still, you probably can’t buy exchange traded funds (ETFs).  You almost certainly can’t buy options.  And there is no possible way you are going to buy any physical gold with your 401k funds.
  8. Some people simply don’t have any money and are living paycheck to paycheck.  The government has ruined medical care, as insurance premiums continue to skyrocket.  The government spends so much money (misallocates resources) and regulates virtually everything to such a high degree, that lower class and middle class America is basically broke.  We are certainly better off in terms of technology, but the reality is that most middle class families are scraping by and have little in the way of savings. It is easy to say that they should save, but life is expensive.  It is better to not contribute to your 401k plan than to stress out about how you are going to pay for groceries this week.
  9. If someone is deep in debt, then that person is likely better off paying off their high-interest debt (credit cards, student loans) than putting this money into a 401k plan.  You can easily pay 18% interest on credit card debt.  After your company match, good luck getting anything close to a return of 18% (let alone half that) with your 401k funds.
  10. To go along with several of the points above, there are opportunity costs with contributing to a 401k plan.  You are locking up your money that could be used in other ways in the present.  You could pay down your mortgage (guaranteed rate of return).  You could get a certification that would advance your career and increase your salary.  You could buy a piece of software or equipment that would allow you to increase your skills and productivity.  If any kind of investment opportunity unexpectedly showed up, you could consider it because you have liquid cash.  If your friend shows up at your door and is looking for an investment for his new great software program that is going to revolutionize the world, you can tell him that your money is locked up in your 401k retirement account.  Maybe it will work out for you because his software idea didn’t take off.  Or maybe he will end up a multi-millionaire while you are waiting another few decades to access “your” funds in the company 401k plan.

Again, these are just considerations to take into account.  Every person and their situation is different.  You have to decide for yourself if contributing to a 401k plan is the right decision for you.

Toronto and Other Local Real Estate Bubbles

Bloomberg recently ran a story on the hot housing market in Toronto.  While it is seemingly good times for those who own real estate there, it also shows all of the classic signs of a bubble that will eventually burst.

The one big problem with predicting bubbles, as with other investments, is timing.  Even if we can accurately predict that there is a bubble, we don’t know when it will burst.  We don’t know how much longer and further it will go higher.

If I owned real estate in Toronto right about now, I would think about selling.  Prices are up 33% from last year.  The average price of a detached downtown home is almost 1.6 million Canadian dollars.  That is about 1.2 million U.S. dollars.  Even the average price for all homes in the Toronto area is getting close to one million Canadian dollars.

This is simply unsustainable.  If you are an American, you may not think this applies to you.  But Canada seems to resemble the U.S. in many ways.  The policies of the two countries are often similar.  There is probably more military spending (per capita) in the U.S. and more domestic welfare spending in Canada (per capita).  But overall, policies are somewhat similar, including central bank policy.

The U.S. dollar has been really strong for the last few years.  The U.S. and Canadian dollars hit parity a several years ago though.  This trend reversed back in favor of the U.S. dollar around 2012.

Not all of Canada is in a real estate bubble, or at least not anywhere close to Toronto.  Vancouver is another Canadian city that is likely in a major real estate bubble.

It is no different in the U.S.  Major cities in California are in a big bubble.  Some of this is due to rent control, zoning laws, and other regulations.  Some of it is just hot money flowing into real estate.  In Silicon Valley, the tech boom helps fuel the real estate boom.  And it is no surprise that Hollywood has a lot of money to bid up prices in that area.

If I lived in California, I would move, unless I had a really great job there.  I don’t see how it is worth it to most people.  I understand that some people love the lifestyle and the culture.  Leftists want to be around leftists, but I know that it goes beyond the politics.  I also understand that some people stay there because of family and the weather.

While you can make a higher than average income in San Francisco and Toronto (to use two examples of major housing bubbles), you have to really be earning a lot to make it worth it.  Why would someone pay $3,000 per month in rent – or higher for a mortgage – to live somewhere?  You could find someplace a bit less expensive, but then why would you live in a tiny apartment and still fork over a lot each month?  What kind of lifestyle is that?

In the long run, this is not sustainable.  The last housing bubble in the U.S. started to pop about 10 years ago.  It wasn’t that long ago.  Yet, here we are again in some areas with prices going up sky high.

I think the current real estate bubble is more local than the last time.  Last time, most of the country was hit hard.  The next time around, only certain cities will get hit hard.  Everyone may get hit hard by a recession, but I don’t think house prices are going to get cut in half as they did in many cities last time around.

It is still a good test to compare rents to mortgage payments.  If you are planning to stay in one spot, then you can add up the costs of getting a house.  This includes mortgage, insurance, taxes, any association fees, and an estimate for repairs.  Make sure to account for repairs.  I just spent over $1,300 to fix an air conditioner, so don’t neglect this.  When you add up all of your monthly costs, is it still less than you would pay for rent for a comparable place?

Sometimes renting can make financial sense.  If you live in Toronto or San Francisco, it probably makes sense right now.  It makes more sense to live in a cheaper area with a lifestyle you still enjoy.

Combining Free Market Economics with Investing