Hopefully that title got your attention. In fact, it’s a variation on the subtitle of an article posted to Slate.com yesterday, Spend Every Dime!, which says that you’ll actually lose money by saving and investing it, so why not spend now? Normally I would ignore such tripe, but this article has been making the rounds on several popular sites and multiple readers have asked me about my perspective on the article, so here goes. It won’t be pretty.
Unsurprisingly, this article was written by Henry Blodget who, along with Mary Meeker, was one of the investment analysts heavily behind the dot-com boom – and he paid dearly when it went belly-up. The end result? He lost his job at Merrill Lynch in 2001 and in 2003 was was charged with securities fraud by the SEC. He’s currently banned from the securities industry for life, which leads us to his career as a writer at Slate, where he basically spends his time slamming the securities industry.
Now that we know who is writing this stuff, let’s take a closer look at it. Here’s the key paragraph, in which he “explains” why saving is a fool’s game:
How does the math work? Let’s say your T-bills return 3.7 percent. If you stash $10,000, you’ll make $370 before taxes and inflation in the first year. Taxes are assessed on the nominal gain (before adjusting for inflation) instead of the real gain, so if you’re in the 15 percent tax bracket, you’ll then pay $56 to the government—and lose about $310 of value to inflation. In other words, you’ll eke out about a $5 real gain on a $10,000 investment (an 0.05 percent return). If you’re in higher brackets, meanwhile, you’ll actually lose about 0.5 percent of value every year. The only time you’ll generate real gains is when “real” rates of return are significantly higher than 0.6 percent (as they are now). But when real rates are negative, as they were a few years ago, you’ll be losing a lot more than 0.5 percent per year.
In other words, his argument is that if you put money into a 3.7% T-bill right now (here’s my earlier article explaining what a T-bill is and how it works), you’ll basically break even in “real value” over a long period, because inflation taxes will eat your gains.
Three Huge Flaws with Blodget’s Reasoning
1. Your other options are far, far worse
Let’s say that instead of putting money into a T-bill, you stuff the cash into your mattress. With inflation at roughly 3%, if you leave that one dollar in your mattress for ten years, it will only have the purchasing power of 74 cents while if you leave it in the T-bill, that dollar will keep its real value over the ten years. Even worse is when you spend that money now. Almost every consumer purchase you make starts depreciating immediately as soon as you buy it, making the actual spending of the money quite terrible.
In other words, Blodget is using a debate technique: argument by selective observation, also known as “cherry picking.” He’s applying a set of facts to the T-bill, but not applying it to the default state, cash.
2. His understanding of the stock market is misguided:
Unlike T-bills or bank accounts, stocks compound tax free, so you won’t owe tax until you sell them (except, again, on the dividends). Yet even stocks aren’t ideal for savings. For one thing, there are those annoying bear markets: The S&P 500 is still below where it was seven years ago, even before adjusting for inflation. Then there are dividend taxes: In the 20th century, nearly half of the average 10 percent annual return on U.S. stocks came from dividends, not price appreciation, and you pay taxes on dividends every year. Lastly, there’s the absurd way that the IRS accounts for “realized gains.” Once you’re in the black on a stock or fund, current tax policy forces you to stick with it—or get socked with a capital-gains tax bill. In other words, even if your stock’s best gains are behind it, if you switch to a better stock, it might be years after paying your tax bill before you get back to even.
This is utter madness. Capital gains tax on dividends does occur, but it’s capped at 15%. In essence, you collect a dividend of $100 – money paid out to you directly by a company without you having to get rid of any of your assets – and you only have to pay $15 on it. That’s significantly lower than the income tax that you have to pay on money you earn from working; if this dividend were treated that way, you’d likely have to pay $28 of it to Uncle Sam. In short, compared to actually working for a living, stock dividends are a very tax-effective way of generating income.
Here, Blodget uses argument by generalization: income that is taxed is bad. Dividends are taxed. Thus, dividends are bad. That’s a terrific fallacy.
3. Most of the article is spent blaming the tax man as opposed to inflation
Inflation eats the majority of your gains on most investments, but it’s an invisible monster: you don’t directly see it on the balance sheet. You only see it when you go to the store and realize that your money doesn’t buy as much as it used to.
This time, Blodget uses my favorite debate fallacy, the fallacy of the general rule. “Uncle Sam takes our money via taxes. Why would he leave us broke like that? Let’s spend instead!” and thus preys upon irrational mistrust of the government in a case where the government actually does a really good job of looking out for individual investors. The truth is that Uncle Sam only takes a small portion of the pie: the real monster in the room is that of inflation, and via the Federal Reserve, Uncle Sam is doing a very good job of battling that monster. In short, Blodget has an axe to grind, and he’s using bad debate techniques to push his viewpoint.
Here’s the truth: over the long run, saving beats spending any way you look at it. You can construct situations where saving doesn’t earn huge returns, but if you use those same glasses to look at spending the money (or even stowing it away in a mattress), those other options are far, far worse. Don’t let some fool with an axe to grind convince you to spend your money irrationally.