Response to Comments on the 10% Compounding Myth

2 Comments

Yesterday, Ramit from I Will Teach You To Be Rich dropped by to leave a comment on my post, the 10% Compounding Myth. Like the writing on his site, it was a well-written piece.

Here’s my response to his comments:

Thanks for the comment, Ramit. As an early user of PBwiki.com, I want to thank you for your part in creating the service (not sure if it’s largely all you or not). I had a good chuckle when you mentioned Datek in your retirement guide. They merged with Ameritrade years ago it seems. I know, I still have a Datek (now Ameritrade) account.

There’s definitely a reason to keep things simple, especially for your site. It’s just that I can find very few examples of sites taking these factors into account in their calculations. It’s always an example of how 8-12% compounds into a high number, never how 4-6% compounds into a respectable number.

And while taxes can be somewhat mitigated, even with 401k and Roth IRAs they are far from eliminated. While you will have control of how much you withdraw and thus the taxes, it’s still likely to eat to be taxed at 20-25% (conservatively) for most people. That’s giving up a quarter or a fifth of all those compounded gains. Clearly giving up 1/5 of the gains on those $300,000 charts is not something to be ignored.

The last point is the best, “what’s the next-best alternative?” The alternative is to educate people about inflation and taxes up front. I understand you need to get readers’ attentions. Show them a chart with the big money compounding at the beginning and they’ll read the rest of the article. By the end of the article though, explain that the big chart doesn’t take taxes and inflation into account and give them those views. That’s what I’d do for Lazy Man and Money, but I think I take a more advanced view that comes from years of reading the basics. It seems you can get the basics anywhere, I want Lazy Man and Money to be more than that.

Ramit, if you were implying the “what’s the next-best alternative?” to investing, there isn’t one - you can’t ignore the inflation and tax monsters. They are as certain as death and urrr, ummm, taxes. Your only hope is to try to outrun them and investing is one of the best known ways. Perhaps you could create a business as Ramit has with PBWiki.

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Rants

Posted by Lazy Man on January 5, 2007

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