Read Time: 4-minutes
Happy Saturday,
Here is this week’s edition of 6-Point Saturday — financial insights to help you make smarter money decisions.
Table of Contents*
*Clickable in the online version.
Point #1 — The Stanford Experiment
“In 2009, Stanford business professor Tina Seelig split her class into groups and issued a challenge:
Each group had $5 and 2 hours to make the highest possible return on the money.
At the end of the challenge, they'd give a short presentation on their strategy…
Most of the groups followed a simple approach:
• Use the $5 to buy a few items.
• Barter or resell those items.
• Repeat
• Sell final items for (hopefully) more than $5.
These groups made a modest return on their initial $5.
A few groups ignored the $5.
They thought up ways to make the most money in the 2 hours of allotted time:
• Made and sold reservations at hot restaurants.
• Refilled bike tires on campus for $1 each.
These groups made a better return on their initial $5.
The winning group took a very different approach.
They had three realizations:
1. The $5 was nothing more than a distraction.
2. The 2 hours of time was not enough to make an attractive, outsized return with a mini-business (like selling restaurant reservations or filling bike tires).
3. The most valuable "asset" was actually the presentation time in front of a class of Stanford students.
Realizing the value of this hidden asset, they offered the presentation time to companies looking to recruit Stanford students.
They struck a deal to sell the time slot for $650, netting a monstrous return on the $5 of initial capital.”
How often have you heard the phrase: “It takes money to make money.”
It’s so interesting that some resources or perceived limitations can actually just be distractions. Seelig summed up the lesson:
“They realized that the $5 was actually a limitation. …the lesson here is that so often we frame problems way too tightly, and if we keep unpacking and unpacking them, we realize that we have resources that are much larger and more valuable than we even imagined. But we also realized that our own skills that we have and the opportunities around us are bigger than we ever thought at the beginning.”
This dynamic regularly appears in our finances. Let’s look at 5 ways — and what to actually do instead.
Point #2 — 5 Attractive Distractions
The last thing you want to do is turn an asset into a liability. But unscrupulous players in financial services or pervasive, destructive beliefs around money can easily trip you up. 5 common, “attractive distractions”:
1. 401(k) loan
Taking a loan from your 401(k) to cover cash flow needs can seem sophisticated, but it adds unnecessary complexity and risks to your plan. You're pulling money out of the market (missing out on growth), and if you leave your job, the loan becomes due immediately. Most people are better off keeping a proper emergency fund in a high-yield savings account and leaving retirement accounts untouched.
2. Trading Frequently
Just because you can trade stocks daily doesn't mean you should. At least not with a significant part of your portfolio. Every trade costs you in taxes, fees, and most importantly, the opportunity cost of not staying invested. Instead, consider building a diversified portfolio and setting a standardized policy of checking it periodically (e.g., quarterly).
3. HSA for Current Expenses
Health Savings Accounts (HSAs) are triple-tax advantaged: contributions are tax-deductible, growth is tax-deferred, and distributions are tax-free if used on eligible expenses. So, while using them to pay for current expenses is fine, the ideal move is to use the HSA to grow wealth over decades. Like I explained to CNBC this week:
“You could also treat your HSA as a hybrid retirement account,” said CFP Benjamin Daniel, a financial planner with Money Wisdom in Columbus, Ohio.
“If you pay for expenses out-of-pocket and create a simple system to save your receipts, you can allow the funds to grow and reimburse yourself later,” Daniel said.
4. Roth Withdrawals in Early Retirement
Whether you plan to retire early or at a traditional age, you’ll need a plan for distributing income from your assets. Pulling from your Roth accounts will sound appealing: who doesn’t like not having to pay taxes? But minimizing taxes in a single year is an attractive distraction. What you really want to optimize for is reducing your taxes over your lifetime. When you’re in a low tax bracket, filling up that bracket with distributions from your taxable brokerage or through Roth conversions is often the better move.
5. Approved for Higher Mortgage
Banks typically approve a mortgage for you for the maximum you can technically afford, not what feels comfortable for you to carry. Or in consideration of your other financial goals. Better approach: first calculate what you need to save monthly for your other priorities, like retirement. Then work backward to determine what mortgage payment leaves room for those goals.
Action Step: Which of these “attractive distractions” makes you think differently about how you could handle your finances?
Point #3 — “401(k) loan for used car?”
Hey there. I work a reliable job making about 90k a year. But I have an older car that I have had since college, a 04 Toyota Camry with 181k miles. I am increasingly having to spend time working on her on the weekends to keep her going and have been considering maybe upgrading.
I’ve seen some decent cars on marketplace. They’re used but newer and with less mileage, better gas mileage for around 7k and was thinking about taking out a loan on my 401k to cover the cost. Is that a terrible idea? I have about 110k in my 401k right now and I’m 35 years old, single. Own a home with a mortgage. Monthly mortgage is about 2,500. Loan rate from the 401k would be 5%
21 years with the same vehicle is impressive, and looking for newer, used cars with good gas mileage is smart. But why is this financing strategy a bad idea?
This person will miss out on the power of compounding. Yes, they would pay it back with interest, but market returns are generally around 7% to 10%.
As Charlie Munger put it:
“But it’s only a 5% rate.”
Correct. But beyond the missed returns, they’re introducing additional complexity and risk. Some 401(k) plans don’t allow additional contributions until loans are repaid, so that also means missed employer matches. Not to mention building the habit of viewing their 401(k) as an easily-accessible account.
Take out a regular auto loan and/or save more for the replacement vehicle. Some options are primarily attractive distractions.
Point #4 — Asset Location, Explained
Speaking of tax-advantaged accounts like 401(k)s, what’s an opportunity most people overlook?
Implementing an asset location strategy.
Most people overly focus on which account types to open (Roth versus Traditional IRA). But there’s enormous value in knowing what asset types to invest in each one.
Asset location means investing in assets that not only are a good fit for your risk tolerance, but also minimize taxes. Here’s an example:
Let’s assume you have 3 accounts: a taxable brokerage, a pretax retirement account, and a Roth (“tax-free”).
For simplicity, you decide to invest in 3 types of assets: high-growth stocks (no dividends), interest-paying bonds, and Treasury bonds (exempt from state tax).
The question: what should go where?
Because you expect the stocks to grow a lot, you might put those in the tax-free account to get all of that growth tax-free.
For the interest-paying bonds? You can defer paying taxes on the interest by investing those in your pretax retirement account.
Finally, the Treasury bonds might go in the taxable brokerage since they're already state-tax-exempt regardless of account type, so you're not gaining extra tax benefit by placing them elsewhere.
Bottom line: Figuring out the type of investing account to use is important, as is determining your overall asset allocation (mix of stocks versus bonds versus cash). But don’t miss the huge opportunity you have by investing your capital in a way that actually maximizes tax efficiency.
Point #5 — Quotes of the Week
Continuing the “Attractive Distractions” theme, which of these is your favorite?
Point #6 — My Question of the Week
What’s an area of personal finance that appeals to you (e.g., optimizing credit card reward points, chasing hot stocks), but probably distracts from your most pressing financial problem?
Reply to let me know! I read every response.
Thanks for reading — I hope you found a helpful idea or two.
I’ll see you next Saturday with more.
Have a great weekend,
Benjamin Daniel, CFP®
Founder, Money Wisdom
P.S. Want to take control of your money, stop stressing about your expenses, & feel confident about your financial future? There are 2 ways I can help you:
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Disclaimer:
This material is not investment or tax advice. No responsibility for loss occasioned to any person or corporate body acting or refraining to act as a result of reading this material can be accepted by the publisher.
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