Mind Your Decisions

Thinking about the 401(k) Account: Should I Have One? How Much Should I Contribute? What are the Risks? Trying to Interpret the Experts

15 May 2008   |   by Presh Talwalkar   |   5 Comments »   |   Print This Article

Planning for retirement raises a number of difficult questions. I’ll admit that I often get confused coming up with answers. And I’m an economics graduate who started investing in high school and enjoys reading financial articles. I have sympathy for anyone that feels overwhelmed or confused by the experts.

I think the main problem is that experts tell you what to do without telling you why to do it. Cookie cutter advice fails with a task as individual as retirement planning. We need to separate fact from judgment, and that’s what I’ll try to do in this article.

I’ve reviewed many expert articles and summarized their answers and thinking below. I also provide a discussion about risks that is notably omitted in most articles.

Do not interpret this as financial advice. Please seek professional help when making decisions.

From what I gather, here is what experts say about the 401(k) account:

–Should I have one?

Yes, if affordable.

–How much should I contribute?

This point is debatable. A starting point is to get the employer match. From there, save more, possibly in a Roth IRA, taxable account, or by maxing out the 401(k) contribution. Some experts don’t think maxing out is a good idea.

–What are the risks?

There are three main risks:

• Money is harder to access
• Investment options are limited
• It’s hard to predict taxes or the future

Below, I provide more details on the answers and give references where applicable.

–Why should I have a 401(k) account?

The 401(k) account is a tax-advantaged way to save for retirement. Here are some articles about the perks:

• employers often match contributions (Milk Your Money, 401kcenter)
• money contributed is tax-deductible (Kiplinger)
• investments grow tax-deferred (Your Investment Advice)

These benefits make the 401(k) one of the most lucrative accounts to save for retirement.

The account is relatively easy to set up. At most companies, you can call the Human Resources department and tell them you want to enroll in the plan. If you are eligible and join, you then need to specify how much you want to contribute. That’s the topic of the next question.

–How much should I contribute?

How can you take advantage of a company 401(k)?

As a starting point, experts recommend contributing up to the company match if possible. That’s because the match is free money, which is hard to pass up.

Financially speaking, free company money essentially softens losses and magnifies gains to your contributions. If you get a 100% match, for example, you can lose an amazing 50% and still break even on what you put in—you’ve only lost the matching money. Alternately, even if your investments grew a measly 1%, you would still be up a whole 102% (you get 100% return from the match, plus 1% growth on your money and the match money).

So far, so good. Now the harder question: should you invest even more than the match?

Most experts and bloggers say yes, it’s good to maximize contributions in a 401(k) (see The Street, CNN Money, FreeMoneyFinance). The account has tax advantages and is one of the best ways to save since money is directly cut from company paychecks.

I think this is a judgment call. There are other places to save that could be much better. Rather than assume what people are disciplined to do, I’d rather know what’s right. And in that sense, I’m not convinced it’s the best thing to maximize 401(k) contributions. Two reasons weigh on my mind.

First, there are important risks to investing in a 401(k) that don’t get talked about frequently. Perhaps that’s why 25 percent of adults are withdrawing retirement funds prematurely, often incurring penalties. Some of the reasons are for medical expenses, vacations, or credit card debt. I wonder if these people could have been better off saving in a taxable account.

Second, even with tax advantages, it’s not clear maximizing a 401(k) yields the highest return. This is a very controversial topic. Two economists have run the numbers and discovered maximizing is not always the best decision. They conclude the average American should contribute to the company match, and then save in other places (like a Roth IRA or a taxable account). You can read about their conclusions in this BusinessWeek article. Here is my favorite quotation from the article:

“If we’re inducing people to save in 401(k)s on the basis of tax savings that aren’t there, that’s wrong”– Laurence J. Kotlikoff in BusinessWeek

The article mentions a software program called ESPlanner that is supposed to help with planning. It sounds exciting.

What are the risks of a 401(k) account?

All investment options come with risk, and the 401(k) is no exception. I tried researching this topic but was disappointed. It seems everyone is so caught up telling people to contribute the maximum amount that risk is only tangentially addressed. If they appear at all, these risks are written in tiny print or as a small hedge.

To come upon a solution, I talked to some very smart people. I talked to a financial adviser, an investment banker, and a hedge fund analyst and drummed up a list of risks for investing in a 401(k) account compared to a regular, taxable account.

1. Money is harder to access

In regular accounts, you can get your money pretty quickly. Just sell a stock or transfer money to a checking account and use it for whatever you wish. It’s easy.

This is not the case with a 401(k). There are restrictions on how you can withdraw the money since the account is really meant for saving for retirement. If you want your money earlier, there are ways but they are not always pleasant. You can borrow against the account or taking an early withdrawal. But these methods might have direct costs (processing fees, 10% penalty) and indirect costs (lost investment time).

2. Limited investment options

In regular accounts, you can generally invest in whatever you want. You can buy any publicly traded stock, or you can withdraw the money and invest in your friend’s private company—a real consideration for entrepreneurs.

In a 401(k), you are limited to what your company offers.

3. Tax issues

Retirement accounts derive many advantages from their tax treatment. In a standard 401(k), you don’t get taxed on contributions now but rather on distributions later. In between, the investments can grow tax-deferred. Shouldn’t a tax advantage mean a tax benefit?

No, not necessarily. The problem is that it’s very hard to predict future tax brackets. Will they go up or down? Which tax bracket will you be in when you need the money?

Here’s another example. If you contribute the maximum to a 401(k), and that lowers your current tax bracket, then you also reduce the value of the tax deduction on your mortgage interest payments.

The standard 401(k) delays paying taxes until withdrawal. There is a newer Roth 401(k) that does the opposite: you pay taxes now but none later. There is much debate about which option is best. Tax brackets aren’t a certainty.

In Conclusion

–The benefits of the 401(k) make it suitable for most people. If you don’t have one, it’s useful to evaluate why not.

–It’s a debatable issue about how much to contribute, but if possible, at least contribute to get the full company match.

–Keep the risks of a 401(k) in mind. You might elect to save in other ways even if they have harsher tax treatment.

5 Comments »   |    Print This Article

Three Ways to Protect Your Email Privacy Using Low-Tech Encryption (Caesar Cipher, Vigenère Cipher, Three-Pass Protocol)

13 May 2008   |   by Presh Talwalkar   |   9 Comments »   |   Print This Article

Every Tuesday is a Game Theory article at Mind Your Decisions

Emails worry me

I wrote half as many emails the day after meeting the company legal staff. I learned that emails are often discoverable in court, and it was rumored company email was being scanned. This whole episode annoyed me, because as a consultant, I enjoyed the convenience of email.

But I didn’t want to join the crowd of world dumbest emails. Here are some examples, described in a CNN article about emails:

• “Can I quit now? Can I come home?” Brown wrote to Cindy Taylor, FEMA’s deputy director of public affairs, the morning of the hurricane. A few days later, Brown wrote to an acquaintance, “I’m trapped now, please rescue me.” ….
• In a Massachusetts class-action suit over the dangers of the diet drug combination Phen-Fen, the court allowed this e-mail from a company executive to be admitted: “Do I have to look forward to spending my waning years writing checks to fat people worried about a silly lung problem?”
• Chevron settled a lawsuit for $2.2 million that involved an interoffice e-mail giving 25 reasons why beer is better than women.
• Former star investment banker Frank Quattrone was convicted of obstructing federal investigations into stock offerings at Credit Suisse First Boston. Central to the case was an e-mail Quattrone forwarded telling employees it was “time to clean up those files” after he learned of the investigation.
• More than 500 of former West Virginia Gov. Bob Wise’s intimate e-mails with a state employee were obtained under the Freedom of Information Act and made public in 2003. The employee’s husband filed for divorce and Wise didn’t seek re-election in 2004.

The stories provide two lessons. First, if you’re doing something very bad, your email will likely be discovered and reviewed. Second, if you write messages that could be taken out of context, watch out.

I imagine the second situation is the worry for us law-abiding and hard-working people. Computer programs might flag our emails, which could be later used against us. Although avoiding email would be best, it’s s not always practical.

The ancients tell us a possible answer

What’s the answer? Searching for solutions, I wondered about our ancients and thought about a solution they came up with: why not send messages in code, just like war generals did?

Coded emails might be the right solution. A small barrier would probably get around automatic computer scanners. And it’s a quick, free, time-effective solution. Computer programs have made the encoding a breeze. And it’s possible to choose which emails to encode, so it’s time-effective. For me, I can continue writing 99 percent of your emails the same way and just encode the few sensitive or important ones.

What code should be used? This is the question that drives the game of encryption, which battles between two opposing forces of security and accessibility. Security suggests strong codes to ward off eavesdroppers who could overhear and crack the code. Accessibility suggests easy codes so intended recipients can figure out the message quickly.

Finding the right balance is the art of encryption. We’ve recently seen digital media rights face this challenge: too little encryption allows for piracy, but too much annoys the end user, as Sony learned a few years ago.

I’ve thought about this issue and come up with three practical ways to encode emails. Each method is more secure than the previous one, but consequently requires more work.

Caesar Cipher

• Turns key words into garbled code; might work against automatic text software (Gmail, company mail)
• Easy to implement

Suppose you want to tell a friend about your new car, but you don’t want Gmail to start sending you ads about cars. Or suppose you want to tell your friend you’re leaving a company in a month, but you don’t want automatically scanning software to flag you.

What method can you use to thwart text recognition software?

The answer is that you can encode your message using the Caesar Cipher. This is a simple encryption where you shift every letter by a certain number of letters. The coded message is easily decipherable, but it looks like garbage to automatic software.

Here’s an example. If you had a 1 letter shift for instance, then the encoding would be:

A—>B
B—>C
C—>D
D—>E
E—>F
….

For instance, the text “car” would become “dbs,” and the word “quit” would become “rvju.”

Here is how you might send a decoded message to a friend.

Hi Bob,

For security reasons, I’ve encoded my message. Go to http://www.simonsingh.net/The_Black_Chamber/caesar.html and decode my message using a shift of 1 letter. Thanks.

“J CPVHIU B OFX DBS. MFU’T ESJWF JU UIJT XFFLFOE”

When Bob receives the message, he can visit the Caesar Cipher, copy the message, and have it automatically decoded:

You can shift by any other numbers of letters too.

The Caesar Cipher is quick and seems like it would beat many automatically scanning tools.

But there is a basic flaw with the Caesar Cipher. Any human that reads the message could easily decode it. Simple shifting is among the easiest of codes to crack.

So a more powerful method is needed, and that’s idea behind the next technique.

Vigenère Cipher

• Turns key words into garbled code; might work against automatic text software (Gmail, company mail)
• Might defeat human eavesdroppers
• Medium hard to implement

The Vigenère Cipher is essentially Caesar Cipher 2.0. It uses a variable shift based on a keyword, which is explained in more detail below.

Implementation is just as easy as the Caesar Cipher. Here is how you might send a message:

Hi Bob,

For security reasons, I’ve encoded my message. Go to http://sharkysoft.com/misc/vigenere/ and decode my message. The key word is the name of the movie we saw last week. Thanks.

“q schshg i esj oae. tvh’f prvdv wg fhva nsrweal”

The extra security layer is adding a key word that is known only to Bob and not an eavesdropper. Bob would know you two saw the movie “Iron Man” together, and thus he could go and decipher the message:

How does the Vigenère Cipher work? It’s essentially a Caesar Cipher with a variable key shift determined by a key word (or password). The description on Wikipedia is nice, and I paraphrase it below.

Imagine you want to encode the message:

COLLEGE DEBT

The person writing the message would first choose a key word, like “help.” If the key word is shorter than the message, then keep repeating it until it’s long enough (computer programs like Sharky’s Vigenère Cipher does this for you). The encoding key word would be:

HELPHEL PHEL

The plain text is then encoded using the Vigenère square, which indicates how letters translate. (image from user:Matt Crypto)

The top row of letters is for the plain text, the left hand column of letters is for the key word, and the middle characters are the encoded letters. For instance, the letter “C” on the top row and the letter “H” on the left column translate to the letter “J” in cipher text.

Repeating the process for all letters, here is the coded, or cipher, text that would result:

Plain text: COLLEGE DEBT
Key word: HELPHEL PHEL
Cipher text: jswalkp slfe

The Vigenère Cipher does have a practical flaw: the receiving person has to know the key word. If you put the key word in the email, the message is no more secure than the Caesar Cipher. If you can’t communicate it, the message becomes incomprehensible.

Also, you might not even want to reveal your key word to the other party if it happens to be a special password that you use for other accounts.

So is there a way you can send an encoded message without revealing your key word?

Amazingly, there is a way. The extra restrictions are the other person needs a key word and the message has to travel three times.

The Three Pass Protocol (Shamir Three-Pass Protocol)

• Turns key words into garbled code; might work against automatic text software (Gmail, company mail)
• Might defeat human eavesdroppers
• Protects your secret key word
• Hard, possibly annoying, to implement

How is it possible to send a message without revealing your key word? An example will illustrate the method developed by Adi Shamir around 1980.

Let’s suppose Alice wants to send Bob a message. Assume each person has a secret password to lock the message (also known as a private key). Here is how the message can be sent, without exchanging keys or giving up security:

–Alice first locks the message and sends it to Bob.
–Upon receipt, Bob locks the message again and sends it back to Alice.
–Alice then removes her lock and sends the message back to Bob.
–At this point, Bob has the message, and it only has his lock. He can simply unlock it and read it.

As the diagram illustrates, the message always has at least one lock during transit to block eavesdroppers, and neither Alice nor Bob has to reveal passwords to each other.

Here is how the three-pass protocol might work in practice for an email, if Alice uses the key word “wonderland” and Bob uses the key word “office space”:

Step 1: Alice encrypts the message and sends it to Bob (“pass one”)

Hi Bob,

For security reasons, I’ve encoded my message. Go to http://sharkysoft.com/misc/vigenere/ and encode the message again with your password, and send it back to me:

“e pbxkye a ahs qnu. pve’s quejr lx ksif zasxhru”

Step 2: Bob “super-encrypts” the message with his own key, and sends back to Alice (“pass two”)

Hi Alice,

“s ugfmcw p ajw esz. xxi’k fugnf qc sumx oaubvwz”

Step 3: Alice decodes the message with her own key, and sends back to Bob (“pass three”)

Hi Bob,

“w gtcill p nga qfw. tgx’k srkzs ny bjmk legossi”

Step 4: Upon receipt, Bob decodes the message with his own key, and he gets the message

Bob gets the message “i bought a new car. let’s drive it this weekend”

As you can see, the Three-Pass Protocol is not always convenient, but it does work.

(Other locking mechanisms can be used as long as they are commutative. That means the order of the locks doesn’t matter; this is necessary because Alice needs to unlock hers after Bob puts on his lock. The Vigenere Cipher is a shifting of letters, so it’s equivalent to addition, which is commutative.)

I hope these methods might serve you well. With so much attention to privacy, I’m sure there are other cost effective methods too.

How do you protect your email privacy?

9 Comments »   |    Print This Article

Line Etiquette Pays: How I Accidentally Saved Money at the Grocery Store

12 May 2008   |   by Presh Talwalkar   |   8 Comments »   |   Print This Article

Recently, the supermarket gods have rewarded me twice with free food. I would like to say I planned this, but it really came about by accident. It happened because I was practicing good etiquette, and I like to think that no good deed goes unrewarded.

What are good manners?

I will take a moment to describe what I mean by etiquette, as it differs from the common meaning. To me, etiquette is not about rules like eating your soup by sailing your spoon away (though these articles are amusing to read). The real joy of etiquette is being considerate to everyone around you and spreading joy. These are things like speaking softly on your phone or giving your seat on the bus to someone needy.

If we all practiced etiquette, we could improve the worst part of shopping: waiting in line. It’s a situation that no one enjoys: shoppers are in a rush to get out, cashiers and baggers are tired from repetitive tasks, and managers are frantic to keep the whole system in order.

Good line etiquette

These are things that speed the process up and don’t bother other shoppers. Here are some things I try to practice:

1. Saying hello and good bye to cashier
2. Avoiding cell phone conversations
3. Having payment and store cards ready
4. Helping to bag own items, if no bagger is available
5. Offering help to identify rare produce

And by far, here is the most important one:

6. Not questioning the price while in line (go to customer service instead)

The first five are common sense. A shopper should be responsible and considerate to keep the line going pleasantly. These things keep everyone’s blood pressure down.

It is the sixth tip that even I sometimes forget, but it’s the most important one.

Tales of bad etiquette

We’ve all seen what happens when someone doesn’t follow the advice. The cashier has to call for a price check and someone runs to the aisle to check the price. During this time, the line is not moving, and everyone gets edgy. Some people try to change lines. Ultimately, the price either gets fixed or the customer indicates it’s too expensive and should be restocked. No one can win in this situation. The shopper looks bad for holding up the line, the store looks bad for having a possible price mistake, and all other shoppers get angry in the meanwhile.

What I do instead

This is why line etiquette goes a long way. I actually ignore the entire price scanning process. It’s becoming harder to do now that stores have installed monitors for me to verify prices, but I try to turn my eyes away. I instead take a few deep breaths while I help the bagger place my items in the cart.

After I’m done, I check my receipt for errors. There is rarely anything wrong. But if there is, I simply walk over to customer service, with the item and receipt in hand and ask:

“Hi, I think this item scanned for the wrong price. Can you help me?”

By going to customer service, I’ve already done the other shoppers a big service by not holding the line. But even better, I am doing myself a service. This is because customer service is exactly set up for these problems. The customer service managers have the tools of:

• intimate knowledge of store sales
• bins to hold rejected merchandise for restocking
• experience that happy, repeat customers should be taken care of

These are things not available to cashiers who work on speed and constantly serve volumes of customers.

This method has worked. I typically get a price adjustment, but I some times get more. Twice recently, store managers have given me a free item because for pointing out the scanning error. I’ve gotten this even when it’s not a posted store policy.

I don’t want to focus on the money since it’s not appropriate to practice etiquette for that reason. We don’t get monetarily rewarded for 99 percent of the nice things we do, like helping a bagger, or being friendly to a cashier. But it’s those rare times we do that should remind us etiquette can pay. Besides, good habits are their own reward.

8 Comments »   |    Print This Article

Your Age by Diner & Restaurant Math–Why the Math Works

9 May 2008   |   by Presh Talwalkar   |   2 Comments »   |   Print This Article

The trick

Here’s one of those fun math tricks I got in the email.

Don’t tell me your age; you probably would tell a falsehood anyway-but your waiter may know!

YOUR AGE BY DINER & RESTAURANT MATH

It takes less than a minute. Work this out as you read. Be sure you don’t read the bottom until you’ve worked it out!

This is not one of those waste of time things, it’s fun.

1. First of all, pick the number of times a week that you would like to go out to eat (more than once but less than 10)

2. Multiply this number by 2 (just to be bold)

3. Add 5

4. Multiply it by 50

5. If you have already had your birthday this year add 1758…If you haven’t, add 1757.

6. Now subtract the four digit year that you were born.

You should have a three digit number

The first digit of this was your original number. (I.e., How many times you want to go out to restaurants in a week.)

The next two numbers are YOUR AGE ! —— (Oh YES, it is!)

THIS IS THE ONLY YEAR (2008) IT WILL EVER WORK, SO SPREAD IT AROUND WHILE IT LASTS

Why it works

To take all the fun out of it, here’s the math behind the trick:

And to generalize

The trick is making the “special number” and 250 add up to the current year. This is why the later subtraction of the birth year reveals the person’s age. The special number depends on whether the birthday has happened.

For 2008, the special number is 1757/8.

In general, the special number is the current year minus 250/1.

So for 2009 it will be 1758/9. For 2049, it will be 1798/9.

I guess this email won’t be stopping any time soon.

2 Comments »   |    Print This Article

Two Nice Articles on Risk

8 May 2008   |   by Presh Talwalkar   |   No Comments »   |   Print This Article

Managing fear while weighing risks

Is your gym locker room crawling with drug-resistant bacteria? Is the guy with the bulging backpack a suicide bomber? And what about that innocent-looking arugula: Will pesticide residue cause cancer, or do the leaves themselves harbor E. coli? But wait! Not eating enough vegetables is also potentially deadly.

These days, it seems like everything is risky, and worry itself is bad for your health. The more we learn, the less we seem to know — and if anything makes us anxious, it’s uncertainty. At the same time, we’re living longer, healthier lives. So why does it feel like even the lettuce is out to get us?

By Maia Szalavitz, Psychology Today Magazine

Why Superstition is Logical

Are you superstitious? I like to think I’m not, but I’m reconsidering after seeing the research of Jane Risen and the other psychologists mentioned in my Findings column. Dr. Risen, a professor at the University of Chicago, knows better than anyone how irrational superstition is. But consider what she does on plane trips.

“I don’t turn my watch to the new time zone until my plane lands,” she told me. “I know that it has nothing to do with whether or not we get to the location without difficulties and on time, but I just feel like it’s presumptuous to assume that everything will work smoothly — and that by engaging in that presumptuous behavior it somehow makes it more likely that things won’t go smoothly.”

John Tierney, New York Times Blog

No Comments »   |    Print This Article