Investing requires making choices.
One such choice: should you invest in a tax-advantaged or general investment account?
Research suggests that, when you invest in a 401(k), the tax break earns you an extra 0.73% each year.
But you also lock up that money until you’re 59 and a half. That’s a risk.
Is that risk worth the benefit to you?
Richard Weller has dealt with risk in his own field.
Weller studies the benefits of sunlight on human health. He currently works as a professor and Chair of Medical Dermatology at the University of Edinburgh.
Weller often points out a study from Swedish researcher Peter Lindqvist. Over a 20-year period, Lindqvist tracked the sunbathing habits of nearly 30,000 women in Sweden.
And he found that sun avoiders were twice as likely to die as regular sunbathers.
Until the industrial revolution, humans spent most of their lives outside. We didn’t have much choice.
“How did we get through the Neolithic Era without sunscreen?,” Weller asks rhetorically. “Actually, pretty well.”
But then in 1956, mathematician Henry Lancaster established a connection between UV radiation and melanoma. For the first time, we had evidence that sun exposure can cause cancer.
The response to that risk was resounding. The American Academy of Dermatology, writes journalist Rowan Jacobson, adopted a “zero-tolerance stance on sun exposure.” Despite our evolution, sunlight became a choice to avoid.
Or, as Weller interpreted the reaction, “Don’t go outside, you might die.”
The New York Stock Exchange launched in 1792. For nearly 200 years, any American who invested did so without a tax deduction. We didn’t have much choice.
But then in 1974, Congress created the traditional IRA. The tax-advantaged account provided a benefit for American savers, particularly anyone who didn’t receive a pension at work.
For the first time, Americans received a tax break for investing.
The 401(k) (in 1978), the 529 plan (in 1996), and the HSA (in 2003) all followed in later years. Despite our investment history, many American investors now relied almost exclusively on tax-advantaged accounts.
Richard Weller never disputed the link between the sun and skin cancer. But he interpreted the risk differently.
Skin cancer kills less than 3 per 100,000 people in the U.S. each year. Most types of skin cancer aren’t fatal. Melanoma, the deadly type, is rare, accounting for only 1-3% of new skin cancers.
Weller preferred to focus on a different risk. He suspected that sunlight also impacts blood pressure. And blood pressure plays a central role in cardiovascular diseases.
He knew from other data that, for every one person who dies of skin cancer, more than 100 die from cardiovascular diseases.
Few people would dispute that tax-advantaged investment accounts offer clear benefits.
A 401(k) plan, for example, can give you tax-free growth. You also might receive a matching contribution from your employer.
But at a certain point, you may start to view the benefits differently. The risk of investing additional dollars in your 401(k) may become too significant to ignore.
Americans, on average, pay 0.45% in 401(k) fees each year. Author Nick Maggiulli reports that your tax break earns you an extra 0.73% each year. After you receive any company match then, you stand to earn only 0.38% extra by investing in a 401(k).
You might prefer, instead, to focus on a different benefit. You might prefer to keep your money accessible to you. You might value flexibility.
Journalist Rowan Jacobson describes what Weller learned about the benefits of sun exposure:
“For three years, [Weller and] his team tracked the blood pressure of 340,000 people in 2,000 spots around the U.S., adjusting for variables such as age and skin type. The results clearly showed that the reason people in sunnier climes have lower blood pressure is as simple as light hitting skin.”
“…Because of its connection to heart disease and strokes, blood pressure is the leading cause of premature death and disease in the world, and the reduction [in blood pressure due to sun exposure] was of a magnitude large enough to prevent millions of deaths on a global level.”
Paying taxes pales in comparison to serious health issues. But both situations raise questions about how we evaluate benefits and risks.
A general – taxable – brokerage account doesn’t feel beneficial. Rather, it feels natural to avoid paying taxes any sooner than necessary.
But we need to keep the big picture in mind. The connection between financial flexibility and living the life we want is strong. We can’t dismiss that benefit.
As Jacobson writes:
“When you spend much of your day treating patients with terrible melanomas, it’s natural to focus on preventing them, but you need to keep the big picture in mind. Orthopedic surgeons, after all, don’t advise their patients to avoid exercise in order to reduce the risk of knee injuries.”
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About the author: Kevin Mahoney, CFP®
Hi, I’m Kevin. I’m a financial advisor in Washington, DC. I’m also the founder of Illumint, an independent financial planning company in the District that specializes in financial planning for Millennials like you. I empower our generation with the confidence to invest an inheritance, financial gift, or extra savings. If you’re new to Financially Well, welcome – you now have access to the leading finance podcast for Millennials. I encourage you to read, watch, or listen to the ideas I’ve shared about making your money work for you. And then when you’re ready, please send me your thoughts & questions!