Why Give?

Let’s first consider the goals of why you might want to give to kiddos in your life:

1. Education - probably focused on college but perhaps for some situations boarding or other private schooling might be something you want to encourage and support.

2. Financial Literacy - you want them to be comfortable and know how to save and invest to improve their future.

3. Ensuring they have an emergency fund - a nest egg they can use to keep minor problems like a car or major appliance breaking down a minor inconvenience rather than an expensive debt at usurious rates.

4. General support - you love them and know their lives will be easier if you grease the skids early in their life.

5. Perhaps you’re doing what you can for your grandkids because their parents are struggling.

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An Adult has to be in the Room

As obliquely referenced in the beginning, the tax code has a lot of vestiges from when people gave money to grandkids to avoid estate tax. Congress wanted to ensure that when people die they’d give money to their kids and not directly to their grandkids. Simply because they wanted estate tax to apply to every generation and not let it skip some. Luckily there are also some programs that help most people and can be easily used by both grandparents and parents.

The IRS allows you to give $19,000 each year to any individual person, without any tax or reporting required. Again they want a chance to tax your estate, this lets you avoid some of that.

Because kids can’t legally sign a contract until they are 18, most investment accounts will require an adult to open one for them and often manage it. Although any adult can do this, and a grandparent might want to, the best idea is to have a parent do it. This has many benefits:

1. It helps with transparency. When you give money to grandchildren you don’t want to unintentionally annoy their parents. Keeping them in the loop and making them part of the process will help avoid hurt feelings.

2. Most of these approaches take years to bring to fruition. Involving someone that has a very good chance of being alive in 18, 21 or 25 years certainly makes things simpler.

3. Oftentimes the older folks have more wisdom and experience than the parents. Managing accounts is a great way to share knowledge with the younger generation. If you are providing initial funds it gives you an easy entry to advise and instruct in the process. One of the best reasons to give to grandkids is to improve their financial literacy, why should the parents miss out?

4. Even involved grandparents probably don’t see the child every night like a parent would. Asking questions and getting fast answers might yield more moments to relay personal finance to the youth.

Calming the Qualms

While writing this I hear the voices of friends and relatives who think it’s terrible to give money to kids. I agree that it needs to be done carefully but most of the objections don’t hold up to scrutiny.

1. They’re too young to understand money. They don’t control the money until they’re 18 or older. Before then they will have the experience of watching what happens over time as the money grows.

2. Receiving gifts will make them indolent and lazy. That might be true if you give them 10mm or more but even a half a million is clearly not enough money to live on for 60 years or more.

3. They won’t save their own money. It’s possible they won’t need to if you are really generous. But already having an account to save will make them much more familiar and comfortable with saving. Having it already set up lowers the bar for them to kick in some of their own funds.

4. They will spend it on frivolous stuff. The guardian generally has a fiduciary responsibility to use the funds for the kids benefit. That doesn’t mean anything the kid wants - you can spend it on their health, education, food, clothes, rent.

At heart you’ll want to raise your loved one to be a successful adult, capable of driving a car, voting. And going off to college by themselves or perhaps starting off on their own by joining the workforce and beginning their career. If they can do all that, shouldn’t they be in a position to understand the value of having a nest egg to make their future smoother? To know to avoid high interest loans for a car or eventually help with a down payment on a house? Some might rely on your gift for the extras that come with a high paying career - allowing them to do something more meaningful for them such as teaching or art. Or perhaps your gift will be more focused.

Let’s cover your options, check out my book for more details.

529 Educational Accounts

These are often offered by your state but might be a self directed brokerage account as well. The state route may offer tax break incentives. The base idea is that you can contribute money to someone’s education. It gets invested and after a period of time if used for educational purposes the earnings go without a tax. There are various limits on how much you can save for an individual and how long you need to keep an investment before it’s available for distribution.

Pros

1. Controlled use for college expenses (or private k-12 with limits).

2. Generous limits for contributions.

3. Some states allow a tax deduction on some contributions.

4. Earnings can be used for qualified expenses without tax.

5. Can be used for various educational programs and professional blue color endeavors.

6. If the initial person doesn’t use it up, the assets can often be transferred to others in your family group.

7. If left over after schooling you can use $7k of 529 assets to fund an IRA.

8. Doesn’t count as the child’s assets when filing out FISA application for College so doesn’t minimize loans.

Cons

1. The best focus is to use it on education.

2. Some state plans have limited investment options.

530A accounts

Also known as “Trump Accounts” they have a number of compelling features but perhaps not enough for extensive use. The account operates a bit like a restricted IRA. Contributions are limited to $5,000 a year which don’t lower your taxes. A third party (including the US Government ($1,000 for kids born in 2025-2028) and for some wealthy benefactors in certain areas) and employers can give up to $2,500. The money is invested in a tax deferred account in a broad US stock ETF until the child turns 18, at which point it essentially turns into a traditional IRA which can be converted into a Roth (paying taxes which may be timed while other earnings have them at a low tax rate) or kept as a traditional IRA.

There are many important details, which you can check here.

Certainly if the child qualifies for funds from the Federal Government or you live in a zip code that gives to older children, or work for a company that will provide initial funding it’s a no brainer to set up this account. And if you’ve given very generously to other types of accounts and have more to give this might be a good choice. However you do want to consider this as best used for the child’s retirement. And as that is a long way in the future it might be more sensible to consider they might need access to money decades before then.

Pros

1. Often comes with seed money from the government or other third parties.

2. Tax deferred earnings.

3. Similar effect as having an IRA without requiring wage income.

4. Automatically invested in broad based US stock index ETFs.

5. Relatively simple to set up - and not much to do once that’s done.

Cons

1. Limited contributions.

2. Limited investment choices - no international/emerging markets.

3. Significant limits on withdrawals.

4. Money effectively tied up until a child retires.

5. Earnings (and free seed money) taxed as ordinary income when withdrawn.

UTMA Brokerage Account

Unified Transfer to Minor’s Act Brokerage Account - like a standard brokerage account but managed by a guardian as a fiduciary for a minor (under 18 or 21 depending on the state). Gifts from parents, grandparents or really anyone can be deposited and invested. Usually the broker will have rules limiting speculative activities like shorting, margining securities to borrow money, selling options etc but investing in stocks, bonds and ETFs are fine. A big advantage is that the minor can file their own income taxes and pay special federal rates of 0% on the first $1,350 of income, and 10% on the next $1,350. After that, any income, regardless of source, is taxed as if it was added to their parent’s ordinary income, and so usually at a high marginal rate.

Still, when carefully managed this can be very tax efficient, especially if you give appreciated stock to a minor. Say you own 10 shares of Microsoft that you bought for $17 in the 1990s. Today that’s worth $4k. Instead of selling it and paying capital gains tax, you can give it to your child, who can sell the shares over the next few years and pay no tax.

When the child comes of age (either 18 or 21 depending on the state) the guardian is responsible for giving them full access to the account. For college aid this will be counted as the student’s money so might impact need based financial aid.

Pros

1. No contribution limits (although gifts from one individual to another are easiest if limited to $19k - a pair of grandparents can give $76k total to two grand kids each year).

2. Many useful investment options.

3. Tax advantages for first $2,700 of income.

4. Long term capital gains/dividends have lighter federal taxes than other income.

5. Child gets complete control when of age.

Cons

1. Tax advantages limited to first $2,700 of income.

2. Child gets complete control when of age.

3. Colleges consider all of the assets as the child’s (because they are) when considering need based financial aid.

4. More paper work and effort to tend to the account than other choices.

Schwab Teen Account

Schwab Teen Investor Account is set up specifically to help teach 13-17 year olds financial skills. The idea is that the parent and teen team up to manage the account. There is also a nice kicker of $50 worth of five stocks to get you started. And few fees to make it better for smaller accounts, otherwise somewhat similar to a UTMA but with a lot of useful financial literature.

Pros

1. Useful financial literature and web based interfaces.

2. Geared to help parents educate children.

3. Comes with $50 of initial stocks.

Cons

1. Limited to older kids - misses longer term investments made for young children.

Fidelity Youth Account

Fidelity has a similar program for the same age range.

Same pros/cons as Schwab except they don’t seed the account with $50 of stock.

Roth Account

If the kid has wages you could offer to give them up to $7,000 to store in a Roth IRA. Neither you or the child would get a tax deduction for that but the account can be freely invested like a UTMA account without the earnings ever being taxed if distributed after they’re 59 ½.

Pros

1. No tax on withdrawals after 59 1/2.

2. Many investment options.

Cons

1. Requires earning wage income.

2. Limited to $7k a year contribution.

3. Limited access to funds for decades.

4. Some paperwork and effort required.

Traditional IRA

Similar to the Roth IRA, but with an initial tax deduction and earnings being taxed when withdrawn. I’m not sure why you’d prefer this to the Roth as if they are in a high enough tax bracket NOW vs the future (which is generally why people prefer Traditional over IRA) you’d likely also prefer to effectively saving MORE by tucking in after tax dollars rather then pre tax as the latter is effectively partially owned by the Government (who has a claim on the earnings as well as the contributions).

Pros

1. Tax deduction on contributions.

2. Many investment options.

Cons

1. Withdrawals are taxed as ordinary income.

2. Limit of $7k pretax is effectively lower than Roth post tax. Since the government taxes your contributions and earnings it’s effectively your partner in the account.

Otherwise similar pros/cons to Roth.

Savings/Passbook Account

Some banks still offer old fashioned accounts where you can earn a small amount of interest without a lot of fees. I tried these for my kids and they learned that earning a small amount of interest didn’t amount to much and was rather dull. No tax advantage for the earnings.

Pros

1. Relatively easy to set up and safe investment - you know you’ll get your money back without loss.

2. Low fees.

Cons

1. Might have to go into the bank every three months to record interest and keep the account open in good standing.

2. Very low interest rate, especially after taxes.

A Physical Stock Certificate

Disney and other companies used to have really pretty physical stock certificates you could register. I gifted my kid’s 100 shares of Disney and framed the certificates to hang on their wall. They still receive dividend checks and enjoy the extra spending money. This made stock ownership concrete for them as well as a nice return. Of course it’d be a bit of work to actually sell the shares but I kinda think they’d rather not part with them.

Pros

1. Looks great on the wall.

2. Physical reminder of stock ownership.

3. Physical evidence of earnings when receive paper dividend check (less so with more convenient direct deposit).

Cons

1. Paperwork required to deliver it back to a broker if you wish to sell.

2. Possible lost or missing dividend checks, especially if you move.

Trust Funds

Very wealthy people can use trusts and other estate planning methods to give children assets. Those allow customized rules that can limit access until a certain age is reached (say 25 or 35) to ease worries of “spoiling” someone’s “drive”. Those situations are more involved so my advice is limited to “don’t expect a substack article to answer all your questions”.

Coverdell Education Savings Account

Congress created these a long time before 529 accounts were a thing. They’re somewhat like them but with much more restrictions both on income limits to contribute as well as the amount you can contribute. They don’t strike me as very useful but you might see them listed so now you know about them. I used these before 529s were available but closed them as soon as I could (you can roll them into a 529).

So how do you choose between these?

Well, first ensure that you have enough squirreled away for your own purposes. Assuming you’ve already thought that through you can choose to use one or more of the above accounts for your loved ones. I’ll give you my take but please understand that no one knows how any of these things will work out, nor do I know your particular situation. I hope this serves to guide you towards a bit more research to ensure you make the right choices for you and your family.

Trump Account - Every kid that would receive money from the government, wealthy benefactor or company should have one of these. It’s not terribly hard to set up and doesn’t require much tending until they become of age. At that point you can make an informed decision of what to do with the money. Adding more to it might make sense if you’ve maxed out the other options - it’s just too limiting with too many penalties that other accounts are more useful. To be clear: you should definitely check if free money is available, my niece found her older sons did as well as her new born.

529 Account - these are also rather easy to set up and don’t need too much tending. Lots of tax advantages and most people hope their loved ones can at least consider going to college and recognize having additional funds yields more possible paths. I used these extensively for my kids, perhaps overly so and have plenty left over for my grandchildren that need it. Being able to switch the beneficiary is particularly useful flexibility. Even a cousin could use the money if desired!

UTMA Account - My parents gave me one when I was young and it worked out really great. So I did the same for my kids with even better results. My wife and I set up one for my grandson and I expect it to be super useful. It’s quite a bit more work both to invest and manage the taxes so they’re minimal. So much better if the size justifies the effort. Otherwise a 529 is a much better bang for the effort.

The accounts at Schwab and Fidelity are cost effective but similar. If you already use one as a broker for your own money they’re certainly worth a look for older kids.

When I was originally doing research for my personal finance book for kids I came across a story that neatly covers what I think about savings accounts for kids. It was second hand and might be apocryphal but still rings true and is educational. A small Midwest town had a local bank who’s president had a grandson in kindergarten. He decided to go into the classroom as part of the bank’s outreach and talked to the kids about banking. He offered to match $10 for anyone who opened a savings account with no fees - the teacher got excited and sent a note home and most of the kids signed up. For a while they competed with each other to deposit allowances and pocket money but soon lost interest. Fast forward to third grade: one kid comes across their passbook and brought it to their parents and asked for the money to buy a toy. So they went to the bank. Apparently in the interim the local bank had been purchased by a big regional bank who changed the fees. Soon all the kids’ parents discovered that the accounts had been charged inactivity fees and were all closed with zero balance. With no notice. I think the kids did eventually get a valuable lesson in personal finance - and it’s a great example of why we can’t trust banks with educating our youth.

Finally, if you do have a UTMA account and the broker provides physical stock certificates as a relatively inexpensive service you should consider the concrete value of displaying a share of some company on their wall. Just be sure it’s something they’ll want for a good long while.

Really finally: if your kid convinces you to let them have a Robinhood account on their phone you might want to ensure they can’t borrow on margin or buy/sell options.

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Disclaimer: none of this is investment advice. I rarely buy bonds and don’t know if you should or not. My goal is to ensure you know enough to follow some of the craziness that’s going on so you can better interpret the news. I assume you’ll skip over the more basic introductory parts if you don’t need a refresher. The main context is that the Treasury secretary Scott Bessent is trying to lower interest rates now while the Federal Reserve seems poised to increase them, all while the debt has grown faster than expected.

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What’s a bond and why buy them?

A bond is created (called issued) by an institution that wants to borrow money for a finite amount of time (or even infinity in some weird cases) and so will pay interest (called a coupon) to the buyer. For example, every Tuesday the US Government will borrow money for 4, 8, 13, 17, 26 or 52 weeks (Bills) or 2, 3. 5, 7 or 10 years (Notes) or 20 or 30 years (Bonds). The bills don’t pay interest coupons but are redeemable at $1,000 so you pay $960 today to receive $1,000 in a year, as if you were loaning at an interest rate of about 4%. Or you might pay $1,000 for a 30 year bond that pays $25 every six months for thirty years when you also get your $1,000 back, which is about 5% interest.

These are known as “fixed income” instruments because you’ll never get more than the promised interest payments and final redemption payment at maturity (your $1,000 back). Other institutions like Google, Apple and Amazon also issue bonds. Rarely longer than ten years and usually for more interest than the US Government pays (Google has recently issued a bond that never matures) and sometimes the “spread” (the amount their yield is over treasuries) these companies pay are very small and essentially at the same level the government pays. Generally the buyer of a US Government bond expects to get paid back in full, so wants a higher interest rate for riskier bonds from a company that might not pay it all back.

Yield vs Price

When you buy a government bond you pay a price in dollars. For example, if you buy a 52 week treasury bill that pays you $1,000 in about a year you might pay $960 for it. If you bought a 26 week bill you might pay $980. It’s much more convenient to think about the price in terms of the implied interest rate you’re getting. Both of these will get you about 4% per year on your investment, which is a much more useful number to think about. So bonds and bills are normally quoted in terms of “yield”. Actually calculating between price and yield is kinda complex and has a lot of pesky math behind it. That’s one of the reason Bloomberg terminals exist. But for most people you can think of it as an annualized interest rate that lets you compare different bonds on a common basis.

Price goes up, Yield goes down

It’s a bit confusing, but when the price of an existing bond goes up, it’s effective “yield” goes down. The idea is that the interest coupon has been fixed when the bond was issued, so if you buy a 10 year bond that was issued a year ago with a coupon of 2% you’re not going to want to pay full price for it today. So while the original buyer probably paid $1,000, you’ll want to pay less, say $850. So the effective “yield” is 4% as you’re earning $10 coupons every six month but you only paid $850. Or looked at differently, for $100,000 you could buy 100 ten year bonds paying 4% (and $100k in ten years) or you could buy 118 nine year bonds paying 2% (and $118k in nine years), and you’d effectively collect about the same 4% interest from either.

The key insight is that if the interest coupon is fixed, and you want to effectively earn more interest you need to pay less for the bond. If you’re okay with earning less interest, you’d happily pay more for the bond.

Or simply remember when people talk about bond prices they might reference yields going up or down to mean the prices are going down or up.

What makes the price change?

Inflation - bond investors want to earn at least a little MORE than inflation on their bonds. So if inflation goes up they’ll want a higher yield. Conversely if it goes down they might find a smaller yield acceptable.

Market Size - if too many bonds are available prices tend to go down as more holders generally mean more people will be in the situation of wanting to sell. On the other scale, if there is a really tight market it can make the bid/ask spread - the difference between the price offered from buyers and that asked from sellers can become quite a bit bigger. Leading to an illiquid market. Generally the US Treasury market is very liquid and hence can offer someone willing to buy if you want to sell, or sell if you want to buy. But if there aren’t enough buyers for a new issue the price will have to go down to attract more.

Default Risk - investors will want to be compensated if they take on a risk that they won’t actually receive all of the promised payments. For US Bonds this is generally low, but with the debt ceiling and fiscal shenanigans sometimes investors get scared.

When Bonds catch a chill the Stock Market gets a fever.

A US Treasury Bond is a great investment vehicle. It’s pretty much guaranteed to pay back the interest, and if you tire of owning it you can often find a ready buyer. It’s backed by the wealthiest country in the world and denominated in a currency that is most easily exchanged with all others. All other financial assets MUST promise the hopes for a better return because none are as safe as a US Treasury bond.

Mortgage Rates in the US (and the world) are usually based on adding a small amount (called spread) on top of the T-Bond yield. So if the ten year bond goes up 0.25% mortgage rates will generally go up at least that much.

Corporate Bond yields move as a spread over bonds to pay for the added risk they might not fully pay back their loans.

Stock Prices are also effected by bond price changes. You buy the stock of a company because you’ll share in their future profits. So if the price of buying the coupons from a T-Bond goes down you’d expect the price for a stock that gives you future dividends will also go down. At the same time, this relation can sometimes invert as in times of uncertainty investors have sold their stock to invest in riskless bonds. So it’s complicated.

The Debt and Deficit

The deficit is the difference between how much the government spends and how much income it collects from taxes and fees. For Fiscal Year 2026 this is estimated at $1.9 trillion. The previous year’s deficit was $1.6 trillion - the increase is due to inflation and increased interest rate payments as well as an increase in spending and decrease in taxes.

The debt is how much the government owes, in part to foreign governments and companies but primarily other parts of the Federal and Local Government and US companies and investors. The total outstanding debt just crossed $40 trillion. Why is that a problem?

There are a few obvious ways that a country can resolve a huge debt:

1. Grow out of it - grow the economy enough that plenty of taxes are generated that can easily pay the interest and also retire some of the debt. On Friday Trump and Bessent said that was their plan, few believe them.

2. Devalue the currency - inflation can eat away at the debt. I’m perfectly happy with the 2.19% mortgage I took out a few years ago, it’s much less than inflation. I’m paying that interest and earning much more from the stocks I bought with the money (having refinanced the home I paid off twenty years ago). Each year the principal is worth less and less in real terms.

3. Bankruptcy - for the US this would really be an extreme form of #2. The Fed could just print $40 trillion dollars and give it to the bond holders.

In normal times you’d expect #1 and #2 to work fine, it mostly has so far. Unfortunately it might have been pushed a bit too much with too many tax cuts at the same time of large increases in govt spending and policies causing high inflation and low growth. Combined with the increased use of the weaponization of the US Financial system leading to most other countries becoming net sellers of US treasuries.

The critical worry is a feedback loop where investors demand ever higher yields so more debt is issued at higher interest rates causing even more debt to be issued to finance those interest payments.

Do note that many Republicans, including JD Vance have suggested this path is the ONLY way to trim a bloated Federal Government with too many social programs. Mike Johnson suggested that entitlement programs like social security represent too big a piece of the spending and must be “adjusted” and “fixed”.

Note that if interest rates spike it will likely mean a lot of problems for the economy as businesses struggle to make money and consumers buy less, generating their own feedback loop of doom.

Seems to me that the only likely “fix” is to replace the government with leadership that will actually cut back on spending (my preference would start with the military and homeland security) and increase taxes. At heart most long term businesses and investors would rather have a strong vibrant base of happy tax payers as customers for their products. It’s really not clear how that will mix with replacing their workers with robots but I’m sure there’s a way. A lot of short sighted folks just want lower taxes. That approach isn’t working for us.

The US Treasury

Often when bad things happen in the bond market people talk about the US Treasury. This is the part of the government responsible for issuing bonds (borrowing money for the Government) as well as maintaining a portfolio of gold bars and foreign currencies so that people feel the currency is “backed” by something “real”. It manages the US Mint that prints currency as paper bills and coins, and collects taxes (IRS) and supervises banks, enforces laws and manages money networks.

The President appoints the Secretary of the Treasury (currently Scott Bessent) and the Senate confirms them as part of the cabinet.

The Treasury has a profound effect on “rates” (the yield) of treasury bonds by controlling how they are issued. They don’t have a LOT of choice over how much to borrow as they need to finance what congress spends money on. They are responsible for paying off the existing debt, which they do by spending the taxes people pay but also by issuing more debt. If there are more bonds investors will need to be rewarded with a higher interest rate to buy them. If there are fewer bonds the natural buyers will pay more for them, lowering the yield.

The Federal Reserve System

I wrote about the Fed in a recent post. It’s a collection of twelve banks in different states with New York being the biggest. It has a really fancy gold vault you can visit where foreign countries can store their gold for free. These banks are a private institution and owned by the big US banks, with the chairman appointed by the President of the US to a four year term, often they’re reappointed.

The Federal Reserve has several responsibilities. It regulates the banks and every night requires each to deposit part of their capital with them to ensure they’re solvent. Each bank takes savings deposits from customers and loans out most of it to other borrowers who pay more in interest than they give to their depositors. The bank is not allowed to loan out ALL of their deposits but most keep some at the Federal Reserve Bank. If a bank has more than what is needed they can loan it to another bank and charge the Federal Funds Rate to them. Setting that rate is one of the primary controls the Fed has over the economy.

The Fed sells the bonds created by the Treasury, primarily selling to some big “prime dealers” as well as some retail clients via their website. Every week they take bids from dealers in an auction for bonds, and allocate bonds to the winning bidders at the highest bid they’ve accepted. So as described above, if there are too many bonds to sell, the Treasury will have to pay higher interest coupons to get them all sold.

The Fed is also tasked with managing the supply of money the economy has. It does this by giving or taking money from the banks. If the banks have more money they are generally encouraged to make more loans at lower interest rates which stimulates the economy. Or if they have less money they will demand higher interest rates and make fewer loans. The Fed gives them money by buying bonds from the bank, which it can do by creating more money on the bank’s balance sheet. Or it can sell them bonds, reducing the amount of money on the bank’s balance sheet. Note that this means that the Federal Reserve bank has a large portfolio of bonds on it’s books. So oftentimes it’s one of the bigger holders of US treasury bonds.

The Federal Reserve has two mandates that guide its operations. It should manage inflation and the employment level. Essentially it wants to continually devalue the currency but not at such a rate that prices rise too quickly as to be burdensome. It also wants to ensure that enough people are working. I view this as they want everyone in the US to be earning enough to pay their credit card bills but not so much that they will stop borrowing.

The Punch Bowl - someone quipped that the job of the Federal Reserve is to take away the punch bowl just as the party gets fun.

Their power to do so has been described as “pushing on a string” - they can set the Federal Funds Rate and can increase or decrease the amount of money in the economy, but neither has a direct effect on the prices consumers pay (inflation) or how many businesses employ workers (full employment). For example: inflation can be created by scarcity when the supply chain is disrupted by laws to protect people from Covid. Businesses can fire people because of such restrictions as well. Foreign countries can pump less oil and raise prices due to scarcity.

“When reincarnated I want to come back as the bond market because you can intimidate everyone.” - James Carville

Congress inherently wants to spend more money than it has. You’d think that inflating the currency by 2% a year and growing the economy at 3% would let you make up 5% more money for the government to spend without requiring taxes or borrowing. But no, there are lots of taxes and even more spending so they increase the borrowing more and more each year. Some politicians seem to want to prevent the government from funding social services by starving it of income by reducing taxes. All seem to have pet projects their constituents or benefactors desire, so there’s plenty to spend on.

The biggest mechanism to control all of this is the “bond market” which is basically all the institutions and investors that buy bonds forcing the government to pay more in interest if they’re asking for too many loans. Other countries store US Treasury Bonds for over half of their reserves in their central banks. Many international transactions take place in dollars so companies store dollars as bills and bonds. Many foreign investors and even drug dealers do as well since it’s the currency of the wealthiest economy. This “reserve status” that is given to our currency makes some things hard but it does allow us to have a lot more debt. Now that we’ve been using the world’s financial system as a weapon it seems countries have become net sellers of our debt. The social security administration has been a net seller of bonds for a few years now. There’s not an obvious candidate for a new reserve currency but it does seem that some in our administration are trying to make that happen.

Recent Turmoil

It’s hard to run a business if you don’t know the cost of borrowing money, or how fast your suppliers are going to change prices due to inflation. Or how many customers will have money to afford your products. While the overall stock market is high, other than a few lucky tech companies most companies have a lower stock price and fewer earnings to go with them. Some are calling that a shadow recession.

The Treasury in the News

There have been three newsworthy items from Scott Bessent the Treasury Secretary:

1. He suggested the Fed allow the Bank of Japan to borrow more US dollars so they can avoid selling their treasury bonds, which they would naturally do if they needed to lower the yen’s exchange rate into dollars as yen would appreciate and dollars would get weaker (so fewer yen would be needed to buy one dollar).

2. He sold the Treasury’s reserves in Euros and bought Yen with them. To protect the Yen so the Bank of Japan could keep their treasuries and not sell hem. European allies weren’t told ahead of time and aren’t very happy about this.

3. He recently said that the Treasury’s new bond buying program in September would double the amount of long term bonds they’d purchase (funding that by issuing more short term treasury bills). He did this when the long bond’s yield broke 5.3% presumably in an effort to increase the prices by soaking up bonds.

As a reason he said that the bond market wasn’t accurately reflecting “the fundamental values” and he had more information and was “right”. I certainly agree he is smarter than me and has access to much more information. But he did come across a bit like a bank president - when he gets in front of news people and says “My bank is solid” it’s usually a sign it’s not.

Someone from JPMorgan characterized #3 as the Treasury paying off their mortgage (long term bonds) with their credit card (short term loan at higher interest rate). That clearly seems accurate even if you believe Scott was paying off the mortgage at a good price.

The new Federal Reserve Chairman

The above actions have created a rather precarious position for the newly appointed chairman of the Federal Reserve. Trump has been quite vocal in demanding a rate cut during the next meeting of the Fed’s board in September. Before Kevin Warsh and others had signaled that they would likely continue selling some of the long dated bonds in the Fed’s portfolio. Which would soak up dollars from the banks’ balance sheet, likely slowing the economy. And at the same time increasing the number of bonds available and hence lowering prices/increasing yields.

Inflation worries generally lead the Fed to increase rates to slow the economy. This is particularly easy for them to do if unemployment is relatively low as it is now.

Obviously increasing rates will goad Trump, who’s threatened the members of the Federal Reserve Board with attempts at firing them and various legal probes over past interest rate increases (or lack of decreases).

There are lots of pressures here, in part some from the Treasury Secretary who’s essentially buying the bonds that the Fed was considering selling. Is it surprising that a President that will celebrate his birthday with a cage fight on the white house lawn wouldn’t also welcome a match between the Fed Chairman and the Treasury Secretary?

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Let’s start on a happier note: If peace came out in Ukraine or Iran it would profoundly lift the economies of India and Europe. Both of their stock markets have been significantly battered due to high oil prices as well as the military threats. I haven’t heard anyone suggest it, but I’d imagine that a real peace treaty with Iran might be possible after the midterm elections as Trump will either give them hundreds of billions of war reparations (as long as his son-in-law can invest it) or he won’t and they’ll give up asking for it. It’s hard to see that they’ll otherwise agree to open the Hormuz while they can still threaten Trump with a democratic congress for his final years. Of course it’s a bit late to actually impact inflation before the election but a better future would help the Republican chances. Whichever way the midterms go, having them done will settle the future somewhat. So come the end of the year we’ll have a better idea of what the future paths will look like. Markets generally prefer a path that is known

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The AI Bubble

It’s no surprise spending 100s of billions on computer hardware has led to a lot of profits for the firms making memory chips as well as GPUs and other computer kit. Surging demand for electrical power has boosted a lot of boats too. Baring a big breakthrough that limits the demand for huge matrix math it seems very likely that Google, Facebook, Amazon, Microsoft and SpaceX/Tesla will continue to build out their data centers. That might slow if they can’t get additional funding from bond investors but forgoing dividends and stock buy backs and firing junior staff is likely to provide for significant growth in the hardware industry. Add in OpenAI and Anthropic. Seems like a really big fleet of ships that is going to stay the course even as it swamps those caught in the way.

One very real caveat about Large Language Models: they proved that they can encapsulate all the known text on the web in a way that’s searchable and more readily useful than conventional “googling”. Their ability to reason has severe limits but even so a bit like a dog dancing - that they can do it at all is the attraction. The area where AI will certainly pay off is replacing people in repetitive tasks like factories where previously programmed robotics were too intolerant of and couldn’t adapt to changing conditions quickly enough. This was always the stated “give me capital” goal of AI and it’s likely to pay off for at least one of players, if not all of them as it becomes commoditized. Without the data centers you just can’t program the robots.

My thesis is that the big tech monopolies have enough natural profits and desire to fund this pursuit of replacing factory workers (and possibly more).

US “Exceptionalism”

Investing in the US has provided phenomenal returns over not just the past decade but century. The country’s laws for employment, tax and especially bankruptcy favors risk takers, inventors and investors beyond others. Up until recently our universities attracted the best and brightest from the entire world, offering interesting people to work with and copious resources - and riches if the results are marketable. Much wealth is inherited as well but based on not royal lines but ancestor’s business results (and crimes). Of course having the only intact industry after a couple of world wars and 40% of the world’s gold didn’t hurt as well.

It might not be the best place to grow up and live in as an average person but for the investor class I’m not sure of better.

China and Energy

While the US has managed to pump more oil, prices haven’t sky rocketed in part because both the US and China have been burning through their reserves to keep prices down. There is much less oil being produced because of both wars and a lot of that battle damage is going to take years to fix. Once China stops using reserves (or runs dry) and starts buying like they used to on the open market prices will spike. China had built up a good part of a year of reserves before Trump/Israel struck Iran. Trump was already using the US strategic reserve to further lower prices in the states. So we’re running low, soon tanks in Cushing Oklahoma will be at their low point and draining more oil will risk the infrastructure failing. So WTI might spike soon as well.

That’s a fairly long winded way of saying that energy prices might go up in a big way, leading to more inflation and a more profound recession. Which have and will continue to show up in some assets’ returns.

Yen Carry Trade

For decades, Japanese Yen interest rates have been very low, so many hedge funds want to borrow in yen, converting to USD and buy dollar assets serving as collateral. This works a treat as long as the USD/JPY conversion doesn’t move too much and as long as the value of the assets don’t fall too quickly. Either could kick off a feedback loop as hedgie after hedgie unwinds their trades by selling US assets driving prices down, begetting others to do the same causing further price declines.

This worry has Scott Bessent (the Secretary of the Treasury) asking the Federal Reserve Bank to relax their constraint on allowing Japan’s central bank to borrow USD by pledging their Treasury Bonds as collateral. Bessent says they should be allowed to borrow much more than 60BB USD a day so they can defend the Yen without actually selling their bonds. The treasury is worried that Japan owns 1.25T bonds (more than any other foreign country) and if they start selling it will drive down the price of treasuries, making it more expensive for the US to fund more debt. Japan is also worried about that (and the associated unwinding of the carry trade) for a lot of the same reasons. It’s like the old aphorism - if you owe the bank a thousand dollars the bank’s problems are your problems. But if you owe a hundred million, your problems are the bank’s problems. The US Government owes Japan 1.25T so they share problems.

That the Treasury/Fed can even consider doing this is a testament to the fundamental advantage the US has in the world. No other country could risk essentially creating their currency in such size and giving it out without worrying about inflating or devaluing it.

Unfortunately, the Federal Reserve System is at heart a private institution. The Government gets to choose the chairman but otherwise the banks are owned by the the other big US banks. They are legally chartered to support low inflation and low unemployment as their sole mandates and for doing that they get to create dollars out of thin air. While they have stretched that mandate to allow for quantitative easing and other advanced financial engineering, it’s not clear that they’ll happily take direction in such a public manner from Bessent. It’s one thing to help the banks directly, it’s another to do so indirectly by helping investors and another country’s currency. Personally I’d be a little happier with the previous Fed chair who was a self avowed Dead Head. While the new guy claimed to be more flexible in his confirmation hearings, his previous beliefs seemed to align with conservative banking. Watch the Yen to see how this goes.

The Fed pushing on a string

In the past couple of decades, the very smart and cunning folks at the Fed have used a number of new and innovative tricks to manage the economy. At first with quantitative easing and later by paying interest on Federal Fund Deposits they’ve showed an uncanny ability to keep the banks solvent and also stabilize the economy. But my middle school history lessons were all about their ability to print money and set interest rates towards their goal of not too many people unemployed and prices not growing too fast. Think of a banker who wants people to always be able to pay back their loans but also stay in the situation of wanting to borrow more to spend on things they can’t otherwise afford. What tools will they use to achieve that when their primary one is setting interest rates? Will that really help when inflation is coming from an increase in energy prices or tariffs? In the past they’ve often set interest rates high to make many more people unemployed and those with jobs focus paying higher rates so they stop spending money and slow down the economy leading to curtailing inflation. That will obviously have SOME effect on prices but if the underlying cause is limited energy it might take a lot of interest rate pain to make the needed impact on inflation.

Stock Market Earnings“Up”

Many firms have published better than expected earnings. Especially Amazon and Google. One concern is that a lot of that excess was in non-operating earnings - particularly valuable was the increase in stock portfolios including some private equity like Anthropic. While that’s a good thing it’s not quite the same as earning more for operating their base business.

There is also some rather suspect “accounting” going on, where Nvidia will make an “investment” in Microsoft that is essentially used to pay for GPUs that Microsoft buys from Nvidia. But wrapped in a “deal” that allows Microsoft to pretend it’s not a committed to pay back the loan. I’m not sure of the details but when things get complicated but look like Nvidia buying it’s own products it seems a bit suspect.

Stock Market Leverage

Margin Debt (investments purchased using the assets themselves as collateral) is at an all time high. 50% higher than last year, that’s a lot. Some brokerage firms are giving access to “carry trade” type rates/machinations to retail clients. At some point prices of something might fall, yielding to margin calls when loans are no longer sufficiently collateralized. If that causes further drops in asset prices leading to further margin calls…

As Homer says: A rosy fingered dawn?

Against all that we have the general arc of mostly peaceful world. There is lots of distress but aside from Ukraine being pummeled most of the world’s factories and economic activity is intact. At heart the new technology is aimed at eliminating dangerous and boring work. Some people will suffer a lot when that happens but overall it’s going to be thought of as progress. Will we get there without a spectacular drop in asset prices? Sure sounds unlikely but we can hope? There are clear risks but perhaps those are just buying opportunities.

Investing in stocks is inherently risky but has paid of really well for the lucky AND the patient investor. A preponderance of the returns have come from owning particular companies and occur on just a few days in the market. Investing broadly and staying in the market has worked really well. Of course one can do better getting out of the market before down turns as long as they get in before things get better. But even the god’s prophesies only help them so much - I don’t think I can reliably do that so I’ll mostly just stay the course.

Churchill said that you can always rely on the United States to do the right thing, after it’s tried all other possible alternatives. I think the same is true of the market.

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When a European investor in Apple receives a dividend, Apple will usually take 10-30% of the dividend and give it to the US Government as “withholding tax”. Much like workers in the US have tax withheld from their paycheck for their income taxes so they don’t owe a huge amount to the IRS on April 15th. The government has treaties with other governments that do the same for US investors in foreign companies.

The US tax code provides a bit of relief for that. If you’ve effectively paid a tax to France, the US will count that towards the amount you owe locally. Unfortunately their benevolence comes at a complexity - you need to calculate how much tax you’d owe to the US and if France charged you more you can only deduct what the US would have charged.

Let’s look at how this plays out in a couple of cases.

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Own a share of ASML Holdings

This company builds the best high tech chipmaking lithography machines and all the big chip manufacturers are eager customers. It is located in the Netherlands so a US investor (via an American Depository Receipt - check out my book for details) will have 15% of their dividend withheld by the Dutch government. So while the company pays 7.50 Euros as dividend, you’ll receive around 6.37 Euros. The amount you can deduct depends on the US treatment of the dividend. If it’s a qualified dividend you might owe 0%, 5% or 15%+ tax on it. If you bought or sold around the ex-dividend date it might be taxed at your ordinary income rate. The US will effectively tax you only on the excess of it’s tax above what you already paid. But if the US taxes you at 5% and the Dutch took 15% your credit is limited to the 5%.

What about Exchange Traded Funds?

ETFs can sometimes pass along their Foreign Tax Credit withholding depending on their structure and their proportion of foreign assets.

If an ETF is more that 50% foreign assets it can pass along foreign tax credits. Since ASML is in VXUS and the ETF is all foreign assets it will pass along ASML (and other position’s) foreign tax withholding.

ASML is also in the NASDAQ 100, but that has a large tilt towards US companies so QQQ will NOT pass along the tax credits. Same for VT, which has a lot of international exposure but not over half.

AOA is an ETF of ETFs, and since its exposure to ASML comes through its inclusion in VXUS it CAN pass along the tax credit.

Tax Form Mechanics

The tax code gives you a choice to lower your taxes by either taking a credit off your tax bill for the foreign withholding, or you could use it as a deduction from your income. Usually the former is much more valuable as you pay a dollar less for each credit, rather than simply lowering the amount you’re taxed on. But Turbotax will ask which you want to do, and if you ask for help will say “you probably want the credit”.

Luckily most brokerage firms will provide all the heavily lifting of gathering which dividends are qualified and not, and which have foreign tax withheld and to which country. They give this information to the Government. It’s up to you to put it into your tax calculations (TurboTax makes this easy) so you actually get the benefit.

Tom’s cranky rant

Remember: The IRS is only responsible to let you know if you underpaid your taxes; if you pay too much they can happily keep quiet about it. And of course the good people at TurboTax have convinced Musk’s “DOGE” team that it’s best if you figure out all your tax details that the government can check instead of asking them to just send you a bill (which most modern countries do). They call that efficiency. No wonder Teslas’ run over strollers in cross walks.

Conclusion

I certainly don’t want to dissuade you from investing outside the US. Most experts recommend 10-15% of your assets should be international/emerging markets. There is some complexity though, and if you’re looking to buy an ETF with international exposure in a taxable portfolio it might be worthwhile to see if it provides Foreign Investment Tax Credits or not. And if not, consider whether a combination of other ETFs would be better. Some have suggested $100 of VT is kinda like having $35 VXUS and $65 VTI.

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There are several popular strategies for retail investors to use leverage and I don’t like any of them. If you look into the details I hope you agree:

1. Buying stocks on margin - your broker will happily lend you money to buy more stocks but it’s a bit like the proverbial banker who’ll loan you an umbrella while the sun is shining and ask for it back when the weather turns.

2. Leveraged ETFs - a relatively new type of ETF promises twice or even three times the daily return of an index. It sounds better than it is.

3. Options - while not strictly borrowing, these give you more exposure than a straight up investment and hence more risk.

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Investing Borrowed Money

Most brokers will let you set up “margining” in a standard brokerage account. The rules are a bit complicated but at heart if you deposit $100 they’ll let you buy more than $100 of stock, often twice as much or more. So you move $100 into the account and buy $200 of a stock by borrowing $100. The interest charged each month won’t be super high but will provide your broker with a nice living. It’s a safe for them as they use your stock as collateral to ensure you’ll pay them back. Let’s look at a few examples to see how this works:

Margin example - stock goes up!

Say you invest $100 of your money into stock X and also invest $100 loaned by the broker. So you start with $200 of X and owe $100 of cash. After a month the stock goes up 10% and you owe 0.5% of interest on the loan (6% annually is about 0.5% a month). You sell $220 of stock and pay back the loan of $100 and 50 cents of interest, leaving a nice profit of $19.50. That’s almost double what you’d have made if you didn’t borrow the money, so you’re pretty happy.

Margin example - whoops, stock goes down

Same set up, but the stock drops 10%. You’ve had enough fun so get out. You sell $180 of stock and pay back the loan of $100 and 50 cents of interest, leaving a loss of $20.50. That’s more than double what you’d have lost if you didn’t borrow the money. A bit of a learning experience.

Margin extreme example - stock takes OFF!

Same set up, but the stock doubles! This is where you need to be CAREFUL. Your $100 investment was doubled once by debt, and then doubled again by market results. So you have $400 of stock. The conservative approach is to take your winnings and pay off your loan. But the gambler in you will shout “you lucky genius! Time to double down!” Since your account has $400 of capital minus $100 of loan you have $300 of “equity” (what you own). The broker will happily give you another $200 to borrow. So instead of selling you might decide to buy $200 more of stock with borrowed money. You started with $100, and now have $600 of stock and a loan of $300.

Ignoring the 50 cents for the margin loan for the first month, you’re in a similar situation as when you started, but with everything three times bigger. That’s where the term “leverage” comes from - like using a pulley or pry bar to multiply the amount of force you can exert your loan is multiplying the return you get.

Margin extreme example - stock craters - Margin Call!

Let’s stay with the happy example of you reaching the player status of $600 of stock with a $300 loan - the same situation as if you’d invested three times the original amounts. But the next month the stock falls 50%.

Your stock is now worth $300, the same as your loan. This time your broker will be calling not to offer you a bigger loan but will ask for a “margin call” - please deposit $100 or he’ll sell the stock to pay off your loan. In reality he won’t wait until the stock drops so much but will liquidate the account well before you hit zero. The rules are complicated but the broker essentially wants to sell your stock while it will still cover the loan, and as it can take a day to reach you that will likely happen well before you’re negative. When the margin call happens you’re no longer in control of when you sell your investment. That’s what makes buying on margin so risky. The stock market is inherently risky and sometimes it can “draw down” 20-30% or even 50% for awhile. In the past those that were able to hold out for an eventual recovery made out a lot better than those that bailed or were forced to sell when the prices were down.

In this case, if you can’t find more money to deposit the broker will sell your shares and leave you with little to nothing of your original $100.

This also happens to the Pros!

Like even Lewis Hamilton can crash when driving too fast, the financial industry is full of examples of hedge funds like Long Term Capital and (last week) Situational Awareness defaulting because of too much leverage. In both cases, the firm picking up the pieces afterwards finds the asset values recover earning them a profit that could have been the original owner’s if they were less levered.

Note that if you have levered the same stocks as others that can make things worse. Their margin calls will lead to selling that will drive your stock down. As you sell to lower your exposure and raise cash you’ll drive it down further yielding more pressure on their position. This can be particularly bad if a big over levered hedge fund has a declared position that mimics yours. Everyone will know and will hold off on buying the “dip” until the faltering folks run out of money and give up. If you do buy stocks on margin, keep plenty of reserve. Limit your borrowing to avoid an untimely margin call. And diversification is generally a good idea but particularly critical here.

Levered ETFs

Some new ETFs promise returns like the popular broad based indexes (or even single stocks) but leveraged to a factor of two or three. While a standard ETF will hold a portfolio, a levered ETF must either borrow money or enter into a derivatives contract to achieve the promised return. Let’s ignore the actual complex mechanics and just assume there’s a loan. Note: the promise is usually to give twice the daily returns of the underlying mechanism.

Happy Example - underlying index jumped 10% two days in a row!

Imagine you invested $100 on Monday am, and over the day the index went up 10%, Tuesday morning your investment is worth $120. And if Tuesday goes as well, Wednesday will see you with double another 10%, which is applied on top of you $120 so compounds to $24 more giving you $144.

Less Happy Example - up 10% on Monday, down 10% on Tuesday.

Like the previous example, but Tuesday things revert. Your $120 drops $24 this time, leaving you with $96 on Wednesday.

Volatility is a killer

There is clearly a random walking risk to the market and that very much hits levered ETFs. When the index goes up for a day, in order to keep the leverage a factor of two, more stock needs to be bought. The reverse happens when the index goes down - stock needs to be sold. This strategy is buying high and selling low. Not very sensible, you want to do the reverse. If the market trades up and down for a bit it can end up net positive but your levered ETF can end up with a big negative. The “two factor leverage” is getting the compounded daily returns but that’s not all the same as doubling the long term return. It only works well when the market goes straight up without many back steps.

Options

You can think of Options as a levered investment as buying one gives you exposure to the price changes of the underlying asset without having to purchasing the whole asset. Say a stock is trading at $100, you might be able to buy an option to buy the stock at $100 in three months for $2. If the stock goes up $10 the option would probably go up at least $5. So for $4 you could buy options with the same exposure as $100 of stock.

Of course after three months, if the stock hasn’t moved your option would expire worthless. So you get leverage but it’s less safe.

Why write this now?

I wrote about leverage, margining and options in my book. Why did I bother writing a Substack article about it? Mostly because the South Korean stock market has cratered and many folks are blaming both Levered ETFs and an extensive number of margin calls for retail clients there. That combined with the increased popularity of levered ETFs here, and that more stock is being bought in the US on margin than ever before - seems like the same might happen here. A reminder seemed timely so you could avoid the crash and also steer clear of the wreckage if others don’t.

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Mutual Funds are simpler

A mutual fund is also a basket of assets that you can buy on a stock exchange so people think of them as similar to ETFs but the mechanics are a bit different. The fundamental idea behind a mutual fund is to allow an investment manager (or firm) to manage money for any client interested in that. For example, say you want to start investing so you open an account at Vanguard and deposit $3,000. You can invest that directly into their “Vanguard 500 Index Fund Admiral Shares”, where at the end of the day Vanguard will take your $3,000 and add it to their investment account containing other’s money invested in all 500 shares of the SP500 index in the proportion to match the index. If someone else has withdrawn $3,000 dollars worth of the fund they won’t actually have more to invest and will simply give you a share of the fund that’s worth $3,000 at the closing prices of that day (known as the Net Asset Value of the fund, NAV). If you were the only trade for the fund that day, the advisor will have $3,000 more in cash to use. If their account before your purchase was worth $297,000 and is now worth $300,000, you will own 1% of the fund. Tomorrow at the opening the manager will invest your $3,000 in more assets to add to the account. If it trades up 1% and at the end of the day is worth $303,000, your 1% share is worth 1% more, or $3,030.

There are several important concepts going on here:

1. You own a certain percentage of the mutual fund.

2. You purchase shares by specifying how much you want to invest. The number of shares you are get are determined by the NAV at the close that day.

3. The Net Asset Value is calculated every night for the basket that is invested. When you buy or sell you transact at that night’s price.

4. There are also fees that the manager will charge for their services. Sometimes when you purchase, sometimes when you sell. Often every year or quarter that is effectively paid by the owners on some date.

5. If there are more purchases than sales at the end of the day, the manager will have to buy more assets when the markets open.

6. If there are more sales than purchases, the manager will have to sell assets to generate cash for sellers. If the assets have appreciated, all the owners of the fund will receive a distribution of “capital gain”. That’s not money but rather a tax bill. It gets added to the cost basis of the fund so it’s really just paying tax earlier than you otherwise would but often annoys people.

Exchange Traded Funds have different mechanics

ETFs also have an investment manager, an account of assets and you can buy them on a stock exchange. But they’re bought and sold like stocks - you buy a share from someone else that already owns it and wants to sell it. Every night the manager publishes the Net Asset Value of the basket just like a mutual fund. However the mechanism to keep the ETF price in line with the basket is done by allowing a few institutions to create or redeem a basket of assets for shares in the ETF.

These are often large hedge funds or investment firms, who are closing monitoring the markets. The ETF manager will publish a list of assets and proportions that will constitute a “creation unit” or “redemption unit” for a large amount of shares in the ETF. If the hedge fund thinks it can more cheaply buy up the assets, put them together in a creation unit and convert that to shares in the ETF and then sell the ETF for more than they spent on the assets for the creation unit, they’ll make a profit.

Similarly, if they think they can buy an ETF, convert it to a redemption basket of assets that they can then sell for more than they paid for the ETF, they’ll make a profit.

Since this can be done by computers on a millisecond basis, the price of the ETFs will very much stay in line with their associated basket, and their market is very liquid as there will always be firms ready to buy or sell the ETF (via the creation/redemption unit cycle).

Note that when the ETF needs to change its investments it can just change the assets that it receives as creation units to be only the new stuff it wants and push out via redemption units what it wants to sell. The important idea is that the value of those units must align with the value of the ETF’s basket.

There are several concepts that make ETFs different from mutual funds:

1. Owning an ETF is owning a company that is associated with an investment account.

2. You purchase an ETF like a stock. So can use limit orders etc that reference exactly how much you’ll pay or receive for a share. There are continually changing quotes during the day so you don’t have to wait until the end of the day to know the real price.

3. There are fees but they tend to be smaller than mutual funds.

4. While there can be capital gain distributions they tend to be minimal or even nothing, even when there are big changes to the underlying basket as the fund can effectively put appreciated assets into a redemption basket and avoid actually realizing a sale.

5. The IRS will tax the hedge funds when they buy and sell ETFs and underlying assets when they make profits. They will also tax a retail client when they buy and then sell an ETF at a profit. Creation/redemption units can be used for the ETF to avoid the tax bill associated with realizing capital gains.

Why are ETFs so popular?

The mechanics make ETFs very popular to brokerage account customers.

1. You can buy and sell them whenever the markets are open like stocks.

2. You can get fancy and use limit or stop-loss orders.

3. You know the price you’re transacting at. You get the current price not the NAV at the end of the day.

4. Fewer fees.

5. Fewer capital gain distributions.

Why is AOA so great?

AOA1 is an ETF that invests in seven other broad based index ETFs that rebalances every six months between the various asset classes without realizing a lot of capital gain tax. You can make one investment and own a balanced portfolio with low expense fee of 0.15% per year, buying and holding for decades if you don’t need the money.

The ETF currently has 80% stocks and about 20% in bonds. 62% of the assets are in the US, most of the other in developed economies with 9% in “Emerging Markets” (which today means that over 1% of the portfolio is in Taiwanese chip factories).

This is a particularly good idea for a taxable brokerage account or an IRA account for a young person who doesn’t want to spend a lot of time managing the fund but would rather invest a bit of money every few months and just buy one thing without spending time researching and figuring out rebalancing.

There are numerous other ETFs that are similar, some of which have more risk to stocks (others have less), or more international exposure (or less). My main point is not about this individual ETF but rather the idea of looking for a single one that can make your future choices simpler with less time checking market conditions and rebalancing. And most importantly, the ETF structure allows you to avoid paying capital gains taxes as you rebalance amongst assets.

Rebalancing

The popularity of different investments wax and wane as investors expectations change and evolve over time. One very popular strategy is invest in many different types of assets in proportion to their historical and natural weights. Stocks generally have had the strongest historical results but with a lot of risky bumps. So many investors own a higher proportion of stocks than bonds, but when one does a lot better than the other they sell and buy the other with the hopes that their popularity will eventually revert to balance. Meaning they want to buy low and sell high.

The same idea can be used for domestic and international assets as the economies do better or worse. The US economy has usually but not always performed better than Europe and Asia so many investors put some money there as well as emerging markets.

Another axis to consider this is based on the size of the companies - big caps vs small caps. For many years the latter as a class delivered better results as small new companies grew into big ones. There’s a lot of ways to consider and balance your portfolio, read my book on personal finance for more details.

The natural way rebalancing is that you sell some of your winners to buy losers that are temporarily out of favor. That tends to result in realized gains that require paying taxes - having an ETF structure deal with the rebalancing saves you not just the effort of figuring out the rebalancing trades and executing them, but saves you from the resulting unwanted tax bill.

If you’re adding more money to your investments you can sometimes avoid that by putting most of your additional investments into the under performing assets. Instead of having to sell the winners you simply buy fewer of them than the losers, tilting the whole portfolio to your desired allocation.

Conclusion

Again, this isn’t meant to recommend AOA or any particular investment. More to suggest an ETF that tax efficiently rebalances for you gives you a good result without a lot of taxes and effort.

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An HSA is often available with a "Qualified High Deductible Insurance Plan”. Instead of paying a lot in insurance premiums you’ll have to pay more before the insurance coverage kicks in. This is aimed at making you a better consumer, especially if you don’t have a lot of health care expenses. Often your employer will also offer you to contribute pretax money to a special account (i.e. an HSA) to use for medical expenses. Some employers will provide a match to encourage you to use these.

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How it Works

Your contributions go into an account that you can take out when you have health care expenses. You can generally pick some investments like it was a 401k so the money earns a tax free return until it’s used. If you have money left over at the end of the year you can use it in the future.

You may need to Pay Upfront for Your Healthcare

Compare a high-deductible plan to a high-premium plan. For the first your premiums are lower, that are effectively funding your HSA. Instead of paying a higher premium every pay check you tuck some money into an HSA. This can cause a big difference if you have a large health care payment in January. Your HSA might not have funds to cover it, so you’ll have to pay for it out of pocket. You can pay yourself back in the future once your HSA has been topped off by your pay check but that can take awhile.

If you lose your job in the middle of the year this can also be a problem, as not having a pay check might mean your HSA never gets funded. In both of those cases, having paid a higher premium for a few months of a high-premium plan might leave you in a better position as you’d pay much less upfront.

If your health care expenses happen at the end of the year your HSA should be able to cover the extra deductible. And if you never have expenses at all it’ll stay in your account for you to use in the future, leaving you much better off than if you paid for a high premium/low deductible plan you never used.

Retirement Nerds “Hack”

No one forces you to use the money in your HSA. You can leave the money in the account and grow it tax free until you need to use it for medical expenses (or until you die).

There is currently no time limit on WHEN you can take the money out for expenses. As long as you had the account when you had a health expense you can keep the receipt for ten years and at that point reimburse yourself for the expense. And that money has earned a tax free return while you waited.

To do this keep careful track of your receipts. If you find that onerous, don’t assume in 2036 you’ll be able to pay yourself back for an expense you had this year.

Flexible Savings Accounts

Some employers offer a different account called an FSA, where you can put pre-tax money into an account to use for health care expenses. That’s great as well, but it’s not an HSA as:

1. It probably goes away if you don’t spend it all in the current year.

2. You probably can’t invest it in stocks.

3. There are lower limits on contributions.

Contribution Limits

The IRS changes the limits each year. For 2026:

1. $4,150 for an individual.

2. $8,300 for a family (two or more people covered by the plan).

3. $1,000 more if the primary insured is over 55 years old.

4. If two people both have employers offering qualifying plans and you’re both older than 55 you get two $1,000 catch ups.

Weird Limitations

Not all health plans have a high enough deductible to qualify for an HSA.

Once you go on Medicare you can’t contribute to an HSA. Also can’t use the HSA for medigap insurance payments.

But if you have money in an existing account you can continue to use it to pay for Medicare part A and other costs.

If the account has money in it when you die your heirs can inherit it but will need to pay income tax on it.

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Terrific launch business - lots of really efficient rockets putting satellites into space each week. Nearly a monopoly on getting big stuff to space and cheap. With proven track record of engineering innovation with lots more coming down the pipeline. Hopefully will one day be profitable, for now perhaps helps StarLink be so.

StarLink - providing fast reliable communication across the global. Only subdivision of the company that actually makes and doesn’t lose money.

Mars Colonization - A million people living on another planet. Feels like science fiction but given the above, somehow doable. Doesn’t everyone want to be involved in that?

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SpaceX feels like a science fiction dream but has a strong track record of engineering innovation aimed at fulfilling those desires. And has great profit margins too (in ONE of the subdivisions)! So what’s not to like? Unfortunately plenty.

It’s mostly an AI company

Elon merged SpaceX with his AI company xAI, and it is NOT profitable and while responsible for most of the “investment”, loses more money. The one thing it’s done well is build large data centers while subverting regulations, like using large gas turbines on semitrailers to provide “portable” power which avoids any permits. While they’ve installed huge amounts of NVidia compute there, to make the finances of SpaceX look better they’re actually renting all of that to one of their biggest competitors. Is that really a good business?

Governance

Elon has spent lots of money on lawyers trying to force him to adhere to laws and standards aimed at preventing self enrichment when making deals etc. He clearly prefers private companies with less constraints, but the draw of allowing executives to sell their stock holdings as well as having better access to his fan’s and index ETF monies is driving a public sale. SpaceX will have two classes of shares, one with ten times the voting rights of which Elon will own 93% giving him total control. And a prohibition of lawsuits (except against fraud) for anyone that doesn’t own 3% of the company. In the past Elon has shown he can do whatever he wants with his companies, now he won’t even be bothered by pesky lawyers when he does it.

S&P 500 Index machinations

There are many rules about which firms get to be included. Two are particularly difficult for SpaceX - needing to be profitable and publicly traded for a year. Elon is pushing the index folks to fast track SpaceX so his company can be included faster and without those pesky conditions.

Initially Small Float

Only about 5% of the company’s shares will be available for public trading for a while. Is that enough to satisfy Musk’s fans? If not it’ll make the price pop at first. Perhaps will mean head winds when the lockups fade away in August and after. So the price might shoot up like a rocket, but if you plan on holding for a while as the float builds the price might fall.

Self Dealing

SpaceX is one of Tesla’s larger consumers - buying 18% of their trucks last year. Some critics suggest it’s a bit like Tesla buying Elon’s solar roofing company when it ran into troubles. What are the chances SpaceX won’t buy Tesla in a couple of years? Other than them all needing Elon’s time why would that be a good thing?

How to make sense of all this?

There are clear echoes to the Robber Barons we see in the Gilded Age. As an investor can you hold your nose and assume there are enough Elon fans that investing alongside him can also make you rich? If things go wrong will you be able to sense it early enough to get out before the music stops?

I like to invest in stocks that have a good chance of making profits, at a price where the market doesn’t seem to recognize that. I imagine that SpaceX will trade at prices where the market doesn’t care if it makes money or not. I understand the draw of being part of a history making endeavor. I fear I’ll own a slice of that via broad based ETFs even if I don’t otherwise feel it’ll be profitable.

Collateral Damage

If the SpaceX IPO fails in some large way (final pricing fails to break 1.8T? Either fails to gain enough retail support or the stock falls in the days following) it’ll likely hurt the coming IPOs for OpenAI and Anthropic. Maybe even signal the popping of the AI bubble.

Hopefully that won’t happen, and rather the natural typical IPO “Pop” will make the stock price jump as fans that didn’t get allocated chunks of initial stock buy up the relatively scare stock on the market. That should leave a nice warm glow for the follow up IPOs (at least until the restriction phases end and increase the float and natural sellers).

Disclaimer: I haven’t read much of SpaceX filings and don’t have a great understanding of the economics of their business. I just don’t have the desire to dig into the details when there are so many red flags at a surface level. So none of this is investment advice. It’s meant more to provide a framework for you to use in looking at this investment. The conclusions are all yours.

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https://archive.org/details/gd77-05-08.sbd.hicks.4982.sbeok.shnf/gd77-05-08eaton-d1t01.shn

Sorry, I promise more financial content soon, but listen to that and you’ll surely profit.

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Every kindergartener knows you avoid the task or do something else to trick the mean witch. You don’t come back and just say “it didn’t work”.

It’s a weird way to teach us the value of reading the classic stories. But that’s the best we can learn for this administration’s mistakes.

Retirement experts quip there are three phases:

• Go Go Years - freshly retired and full of energy.

• Go Slow Years - more naps and less activity.

• No Go Years - can’t chase life, hope it reaches you at home.

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The Go Go Years

You just start retirement and are redirecting that energy you used at work to new pursuits. You might work part time but you feel pretty healthy and can spend active time with your loved ones. Many travel internationally or domestically. You have time for more outdoor activities like skiing and hiking.

The Go Slow Years

You have some energy but prefer board games or playing cards with your grand children rather chasing them around a playground. You can still drive but prefer to be a passenger for a trip longer than a couple of hours. Similarly long distance plane travel doesn’t feel pleasant. Swimming is fine but skiing is no longer an option. Hikes for a couple of flat miles possible but carrying a small water bottle must suffice.

The No Go Years

Activities of daily life can sometimes be enough of a struggle. You need more help to do, or perhaps remember to do - things you used to do without thought or pain. You go to the doctor more often than dining out.

Listen to your Internist

Although we can’t guarantee we’ll spend any appreciable time except in the last phase, doctors give us plenty of good advice. Your health is critical to a longer and happier retirement.

Exercise - not necessarily to lose weight but to keep and build your muscles and core strength. Being active keeps your bones stronger to help them survive a fall or heal from an injury.

Balance - yoga and friends can keep you steadier on your feet so you avoid injury.

Skin - you want to be outside but with sunscreen. If you tanned when younger, especially with fair skin check with your dermatologist. I need to see mine once a year to check for troubles.

Mental - keeping your mind sharp. Puzzles, games etc. Your work used to constantly challenge your mind and you need to replace that so you keep your wits quick and agile.

Friends - social isolation can lead to depression. Having a network of people is critical to all of the above. Stay in contact with old coworkers and friends. Go out of your way to cultivate new ones.

Sex - while not often discussed, it seems likely this can help keep you young. The NYTimes seems to think so.

Put all this together and retirement means your still working but on yourself. You want your activities to keep you healthy, your mind sharp and interacting with loved ones and new friends.

What it means for your finances

Most people find that their spending is higher in the first phase. At first there are lots of activities that use some resources. And less expense as you do less and life becomes quieter. In the end medical expenses and care can create an uptick but for most people it tends to be muted and never grows back to the spending level of the first phase.

So consider this when you’re planning about cash flows and withdrawal rates. Recognize that if you deny yourself spending in the beginning it can hasten your transition to the Go Slow phase. That doesn’t mean expensive purchases are needed for your happiness but rather you shouldn’t put off a vacation you’ve always wanted as it might be less enjoyable in the future.

You also want to ensure someone can help manage your finances as well as make health care decisions if needed. I maintain a paper document listing all the accounts with contact info and a brief description of what should happen if I’m not able to deal with them.

When you first retire

One of the best things you can do for your finances is to improve your health. Many people struggle with where to spend their time as their work defined a large portion of what they thought about, what they did and who they felt they were. This makes perfect sense as how can you spend 9-14 hours a day doing something without associating strongly with that activity? Sure you have more time for hobbies but many people find they don’t easily scale up and leave a bit of an unfulfilled void.

Luckily the doctor’s advice can help.

Spend time and effort to get into shape. Take yoga or Pilates classes. Strength training or low impact running if you can. Do something every day that moves your body and gets you into the sunlight.

Those and other classes or even hanging out in public places or walking dogs can help provide a human connection that is also critical to you.

Your money is important but fails to compare to the health of your body and mind. Make a plan for what you will do to stay healthy and follow it. If it doesn’t work, change it until it does. Ask experts for help if you need them, I’m not one but I do know it’s the best investment you can make.

What to Do

Many things are only good in moderation. A little bit of tv and passive social media are fine. You need to consider them like sweet treats. If you find you’re spending your day binge watching eye candy you need to figure out a way to limit it.

Retiring doesn’t mean you stop the desire to produce things of value, stop interacting with people or stop learning. It means we don’t have to always do that everyday and don’t need to listen to a boss or client telling us exactly how to go about that. Nor placate an over demanding customer. Retirement is good and should be enjoyable. You need to recognize the innate need we have for valuing ourselves and helping others. Most of us have a drive to make the world a better place. There are many forms that can take.

Gardening is a great way to learn and improve your living space.

Creating art even if no one else sees gives you new skills and insights into the medium you use and the world you portray.

Volunteering in community centers, schools or other public institutions can give human interactions we need and provide a sense of value.

Taking a yoga, Pilates or other exercise class gives a sense of community, an opportunity to make friends and build up your health.

Helping out with grandchildren or baby sitting other kids if you don’t have the former close by can be exceptionally rewarding and tick all the boxes: you feel needed and challenged. Learning and building a meaningful connection with others that you can always cherish.

Get out of the house every day even if just for a walk. Greet neighbors and strike up a conversation. Many people are reticent to talk to strangers and just need a little encouragement.

It’s okay to also rest, relax and enjoy the freedom not officially working gives you. But the quickest way to the No Go phase is withdrawing from others and stop working on yourself and a better world.

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As you live longer, since you haven’t already died your life expectancy grows a bit. Women tend to live longer than men, but that gap shrinks over time.

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Graphing the number of deaths at each age provides some more insights:

• More men die between 55 and 75 than women.

• Women live longer, and cluster more tightly around their average.

• Infant mortality is an important factor even today.

Improving your odds

Those are averages, several factors can shade it one way or another.

Wealth - in many ways it’s not right but wealthy people in the US live a lot longer than poor people. This is most noticeable in the extremes where the top 1% of men live 15 years longer on average than the bottom 1% but it’s a general factor for women and for all graduations or wealth in between. So where you are on the wealth spectrum should add or subtract your expectations accordingly.

Health - if you’re in better physical shape you are more likely to live longer than if you aren’t. Not smoking helps a lot. Family history of cancer and other life threatening diseases matter as well.

This Harvard researcher suggests that men can live longer by avoiding risky behaviors and seeing the doctor more (untreated heart disease might take its toll and explain the excess deaths after 55 for men).

Social Network - if you have strong friendships and/or family close by it can help prolong your life.

Marriage Helps

Being married can help tick some of those boxes. It can also give you additional options at the risk of more complexity in your finances. If your relationship is good and at least one of you is healthy there is a chance you will both live longer than if you were otherwise single.

Also, you might want to consider that one of two people is more likely to live longer than just two single folks. It’s just the way the math works. Let’s spend some time to better understand that.

Imagine that two individuals’ lifetimes are each represented by a single die. They are both old and roll a die that will determine how many more years they will live.

There are six equal possibilities for each roll: 1, 2, 3, 4, 5 or 6.

That totals to 21, and as there are six possibilities we divide 21 by 6 to get an expected 3.5.

So each person is likely to live another 3.5 years.

Now let’s look at the likelihood one of the two will be alive. Consider all combinations of the two dice and take the maximum of them:

Their sum is 161, divided by 36 yields an average of 4.5.

And all the combinations looking at the minimum:

Their sum is 91, divided by 36 yields an average of 2.5.

In this simple model with two married people:

• Each separately is likely to live another 3.5 more years,

• The first to die is likely to live 2.5 more years and

• The last alive will likely live 4.5 more years.

For a married couple, one of the two is much more likely to live even longer than their individual life expectancy. And it’s likely that one will die sooner than their individual expectancies. It’s just the way the combinations work.

Analysis

You want to plan on one of you surviving longer than the individual expectancies will give you. You can use the tables here to help with that. Or this tool from from a group of actuaries who specialize in this stuff.

You also want to consider that while both of you are alive, your tax rates will be much lower than when only one of you is left because at some point you will go from a filing status of “married” to “single”. If you have a substantial traditional IRA you should consider converting some of that to a Roth while you enjoy the lower marital tax rates. In addition to lowering the tax rate you’re paying it will lower your Required Minimum Distributions and give you more control over your finances.

Both of these statistics also play into the calculus for when to start taking social security as the survivors benefit for the higher of the individual benefits will likely last longer than the standard SS admin calculation assumes (which is based on individual life expectancy for the average person). So waiting to collect the higher benefits until 70 while taking early distributions on the smaller might be a good strategy. That will ensure the longest living will have the max benefit and also that the shorter will start collecting early. Of course if you both have a long life expectancy so the first to go is likely to be past the break-even point of waiting on social security (82 or so) then waiting for both makes the most sense if you have sufficient other sources of income.

Of course the most important takeaway is that the combined effect of being married on your individual longevity and the joint probability of a single life living longer is an important consideration for how long you’ll want your money to last.

Note that none of the above takes into consideration future breakthroughs in medicine and support. If you’re starting out on your retirement journey you should consider it a long one. If you start the process by getting into better shape you’ll have the best chance of really enjoying it.

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WAR!

The bond market cares about tragedy only to the extent that it impinges on economic growth. When there is global conflict investors can get worried and pull money out of stocks (causing their prices to fall) and move their funds into “safer” assets (which should rise). Traditionally that’s gold and US Govt bonds. Those that fancy crypto would like to add Bitcoin, Ether and the stable coins (crypto tokens explicitly matched with hard cash assets) but that effect doesn’t seem strong.

The Iran conflict initially fit that pattern. The initial attacks seemed to have been successful and although likely to cause oil prices to spike the actual impact on stocks and bonds was somewhat muted. As news of 175 people dying at a girls school came out I figured that would be another good reason for the US to declare victory and stop further attacks. Instead Iran struck back hard at over a dozen other countries and the US and Israel have kept at it.

The economic fall out seems pretty significant as 20% of the world’s oil flows through the Strait of Hormuz that Iran has declared to have shut down. Also 30% of Urea exports and many other fertilizer products travel there. As the region has lots of natural gas with relatively few pipelines it’s convenient to turn it into nitrogen and other fertilizer components. Much is imported to India and Brazil but it’s likely to also hit US farmers as prices will go up. China has recently built up a large strategic oil reserve, but the US coffers have been kept empty to help drive US gas prices down. All of which implies that if Iran can keep the straits closed as they’ve promised to do through the midterms, or even just more expensive to insure passage through them, the world will pay more for oil and food. Likely leading to inflation.

Given how events rolled out, the market dropped a bit at first, and then more extensively as it became clear that this wasn’t a quick one-and-done event. This was layered on top of an already complicated economic context.

Shadow Recession

The US economy is technically still growing. Gross Domestic Product (GDP) has to contract for two quarters in a row for economists to declare a recession. However that measure isn’t all that useful. My dad taught Economic History and always told me “If I take in your laundry and you do mine we’ve increased GDP, how does that help anyone?” Below I’ll describe why that is EXACTLY what’s happening now.

Otherwise there are the classical signs of a recession. February Jobs Report has 92k jobs lost. Recent college grads are having real struggles finding employment.

Credit card and car loan delinquency rates are back to the rates last seen during the great recession of 2008-2010.

Wealthy people with high incomes or big stock portfolios are spending enough to keep consumer businesses in the black making things seem better than they are.

Most of us feel a crunch as the Govt payouts and forgiven loans to keep things going during COVID have been used up and the inflation overhead from supply chain issues and costs and disruption from tariffs have left prices high and savings accounts low.

The shine is off AI

Investment in new AI techniques has buoyed the stock market to incredible highs. Now that that party looks over. The techniques to train Large Language Models to encapsulate all available text on the internet so it can be played back to simulate thoughtful responses require huge data centers to store and do the calculations. These are expensive and use a lot of energy which is likely to drive up natural gas prices as the US is also exporting more of it than ever. The big AI firms hope to be able to fund both the data centers and the power grid enhancements but their accounting has been called into question. Some have promised to pay for chips and data centers for ten years but structured the transactions so accounting only counts for two years of them.

More worrying is Nvidia, AMD and Amazon are making deals with Meta (Facebook) and others where the chip makers invest billions of dollars in stock of the data center companies along with contracts for them to buy the chips. And data center companies are investing in the AI companies who in turn promise to use the data centers. Microsoft recently invested $5b in Anthropic with the promise they will spend $30b using Microsoft’s data centers.

While I continue to believe that LLM models are terrifically useful tools and hope they will make smart people more productive, that’s mostly for a future payoff. For now this very much meets my dad’s definition of taking in each other’s laundry. I join others in suspecting that companies have cut hiring giving AI productivity as an excuse rather than a more truthful acknowledgement that demand for their pricey products has fallen.

What happens next?

Is there enough concern about the AI companies being overvalued for their lofty prices to continue to drop? The administration will be rolling out retirement accounts for babies with $1k, that should help buoy the stock market for awhile. It seems unlikely that the promised payout financed by tariffs won’t happen soon if at all. Seems most likely that the recession will come out of the shadows. Especially for the wealthy who keep their assets in dollars as the others rush to buy foreign stocks and bonds (including other central banks). Can the FED intervene to protect the currency as well as the market? Or will it need to raise rates to help the dollar and keep people buying bonds while sacrificing the economy on the altar of inflation?

Those are a bunch of open questions. There are some other important longer term ones involving immigration, the dollar keeping the reserve currency, the deficit, income and tax disparity, and frankly how much the govt should trust and help a few billionaires to guide our society to explore space. I don’t feel I have particularly useful insights to give on those. My focus here is that if you feel the economy is hurting I think you are right. And if you don’t I suspect you will soon.

The US President demanded and got a Nobel Peace prize, set up a “Board of Peace” and follows up with a huge air strike on Iran to support Israel taking out their leadership at a big ill advised meeting above ground. Which leads to a general Fatwa against the US and closing the strait of Hormuz out of global spite. I love irony but I give up guessing what will happen next.

As always I hesitate to give specific investment advice. Personally I find it hard to keep up with the present. I will say that VXUS is an interesting foreign stock ETF that isn’t hedged against currency risk. So if you feel the future will favor either foreign companies or a weaker dollar (or both!) that might be of interest.

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Back in 2024 I found some super generous offer from Robinhood to transfer my brokerage accounts. It was too hard to pass up and I didn’t really understand the limitations they had as a firm. It’s great for ease of use, but not at all as sophisticated as any of the dozen brokers I’ve used before (being in the business I had to change with each job). I stuck with them until I officially earned the bonus.

While setting up my taxes for this year I remembered that I pulled some cash out of my brokerage account last year when the markets fell a lot, and some of the bonus that I received from Robinhood in 2024 got “clawed back”. I saw this at the end of the Brokerage Statement.

Being the “I hate paying taxes nerd” I am, I’ve found that the IRS allows this type of thing as Internal Revenue Code (IRC) Section 1341 as a Claim of Right. The more general case is that you paid tax on income in a past year that you were forced to repay in a later year. Details are here on the IRS website (for 2024, like most of the site they're not updated for the new year yet).

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IRS Guidelines

If you had to repay an amount that you included in your income in an earlier year, you may be able to deduct the amount repaid from your income for the year in which you repaid it. Or, if the amount you repaid is more than $3,000, you may be able to take a credit against your tax for the year in which you repaid it. In most cases, you can claim a deduction or credit only if the repayment qualifies as an expense or loss incurred in your trade or business or in a for-profit transaction.

Type of deduction.

The type of deduction you’re allowed in the year of repayment depends on the type of income you included in the earlier year. In most cases, you deduct the repayment on the same form or schedule on which you previously reported it as income. For example, if you reported it as self-employment income, deduct it as a business expense on Schedule C (Form 1040) or Schedule F (Form 1040). If you reported it as a capital gain, deduct it as a capital loss as explained in the Instructions for Schedule D (Form 1040). If you reported it as wages, unemployment compensation, or other nonbusiness income, you may be able to deduct it as an other itemized deduction if the amount repaid is over $3,000.

For tax years beginning after 2017, you can no longer claim any miscellaneous itemized deductions; so, if the amount repaid was $3,000 or less, you aren’t able to deduct it from your income in the year you repaid it..

Repaid social security benefits.

If you repaid social security or equivalent railroad retirement benefits, see Pub. 915.

Repayment over $3,000.

If the amount you repaid was more than $3,000, you can deduct the repayment as an other itemized deduction on Schedule A (Form 1040), line 16, if you included the income under a claim of right. This means that at the time you included the income, it appeared that you had an unrestricted right to it. However, you can choose to take a credit for the year of repayment. Figure your tax under both methods and compare the results. Use the method (deduction or credit) that results in less tax.

When determining whether the amount you repaid was less than $3,000, consider the total amount being repaid on the return. Each instance of repayment isn’t considered separately..

Method 1.

Figure your tax for the year of repayment claiming a deduction for the repaid amount.

Method 2.

Figure your tax for the year of repayment claiming a credit for the repaid amount. Follow these steps.

1. Figure your tax for the year of repayment without deducting the repaid amount.

2. Refigure your tax from the earlier year without including in income the amount you repaid in the year of repayment.

3. Subtract the tax in (2) from the tax shown on your return for the earlier year. This is the credit.

4. Subtract the answer in (3) from the tax for the year of repayment figured without the deduction (step 1).

If method 1 results in less tax, deduct the amount repaid. If method 2 results in less tax, claim the credit figured in (3) above on Form 1040 or 1040-SR. (If the year of repayment is 2023, and you’re taking the credit, enter the credit on Schedule 3 (Form 1040), line 13b, and see the instructions for it.)

I’ve moved to E*Trade

I’ve been rather unhappy with Robinhood, mostly as tracking short vs long term gains, and tax lots is very rudimentary. I managed to keep most of the bonus by waiting a full two years (one more to go for the Roth IRA but that was even more generous).

The credit approach is only available if the amount is over $3k AND you believed the bonus was unrestricted. So be prepared to defend that last bit if the first is also true.

I added the amount to TurboTax desktop under the “Deductions & Credits” | “Other Deductible Expenses” | “Tell us about your other expenses”. So I’ve effectively lowered my income this year due to Robinhood clawing back money they gave me in 2024.

Hope that helps if you’re in a similar situation. Again, that’s what I did, seems right to me but I have no idea if it’s really the case so best of luck if you do it.

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Contributions while working

If you’ve earned wages while working you’ve most likely contributed to social security. The current rate is 6.2% of your wages below $184.6k which you pay and a similar amount for your employer. If you’re self-employed you’re responsible for both. Some folks that work for the Federal government are covered by a different pension system so don’t contribute.

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The Social Security “Trust Fund”

Originally Social Security was designed as a “pay as you go” system where current workers would essentially provide a pension for older retired workers with the understanding that younger people would provide for them in turn when they retired. As long as the former significantly outnumbered the latter this would work nicely. In the late 1970s and early 1980s it became clear this would no longer be the case so the social security taxes collected were increased, and essentially invested in US Treasury bonds to form a trust fund (actually two funds) to represent the debt of future tax payers to future retirees. As the “baby boomers” have aged, this fund is no longer growing but shrinking. If nothing happens it’s estimated to be gone sometime in the next decade. Several proposals that seem politically feasible have been suggested to make it last much longer, e.g. eliminating the cap on wages that are taxed etc. It’s important to note that even if the funds drop to zero, current taxes would continue to supply over 70% of the expected outflows. Given the popularity and importance of the program it’s likely to continue in some form regardless of what social media quips suggest.

Who can Collect

Social Security supports some disabled people and in many cases spouses or young children of workers that contributed. But the bulk provides for retired people. You should set up an account on The Social Security Administration's portal to find out the details of your situation, including a detailed history of your contributions and expected benefits. There’s a procedure to correct any mistakes in their historical record.

For retirees born in 1960 and later your full retirement age is 67. For those born in the 50s it’s a little earlier, 66.

You can start collecting at age 62 but your benefits will be permanently reduced for each month you collect early. Your monthly benefit would be reduced up to 30% if you start collecting at 62.

You also have the option to wait until you’re 70 to collect. If you do your benefit will be increased commensurately. For me that would be 24% extra. There is no additional benefit for waiting beyond age 70.

Once you start collecting benefits you can change your mind and stop for awhile. While in hiatus your future benefits will grow.

Married Complexity

If you are married, or were married for a long period you might have other potential benefits as well.

A spousal benefit can give you 50% (or so) of your spouse’s benefits instead of whatever benefits you’d otherwise be entitled to. Meaning if your spouse earned more and so contributed more heavily it might be better for you to take spousal benefits instead of your own. Note: you can take the spousal benefit early or late without regard to when your spouse starts receiving the benefit.

Also, if you survive your spouse, you are entitled to either yours or their benefits, whichever is larger. Note: your option is to receive your spouse’s benefit instead of your own. That amount is set if they’ve already started to receive the benefit, it doesn’t increase if you delay asking for it.

There are many details, check the SSA website, or call one of their agents to walk you through your exact options.

Taxes

Unfortunately social security benefits are sometimes taxable.

If you make too much money ($25k for individual filers, $32k married in 2025 1) up to 85% of the benefits received will be taxed. Note that there is a new $6k deduction temporarily available for some people over 65 in the Big Beautiful Bill that lessens this bite.

If you continue to work and earn wages before your full retirement age and after you’ve started collecting benefits, some of your benefits will be delayed. Meaning instead of receiving all your benefits now, each dollar you earn over a limit will reduce your benefits now. If you were to stop working you’d receive these as extra payments in the future. So it’s a bit like a tax.

The rules for these are all rather complex. Congress went out of their way to help people in specific income levels, so the very poor without wages don’t pay taxes and so don’t get any additional help, and the help for those in the middle goes away at higher income levels where their benefits are taxed. Look up the particulars to understand how this applies to you.

COLA

Two factors make Social Security very important and useful.

COLA - Cost of Living Adjustments - every year your benefits will be adjusted to allow for inflation. So as things get more expensive your benefits will rise so you ought to be able to continue to afford them.

Paid as an Annuity - You receive your monthly benefit for the rest of your life. A very real risk for a retiree is whether you’ll outlive your money. Having this guaranteed income if you live an extraordinary long time is very nice.

Think of your social security as equivalent to owning a very long term Inflation Protected Treasury Bond. It’s protected against inflation, and is guaranteed to be paid. So even if you have a healthy stock-only portfolio, your social security benefits make it as if you have a healthy position in bonds.

When to Start Collecting Benefits

Most financial advisors strongly recommend waiting until age 70 to collect. Your benefits will be bigger and it’s a very good way to hedge against you living for a very long time.

It’s interesting but most people decide to take benefits as soon as they retire. Or even earlier. I can think of several reasons for this.

• I need the money now. I don’t have any other way to pay for my living expenses so really don’t have a choice.

• Who knows how long I’ll live? I might as well start getting some now.

• This is the first time the govt owes me money and I want them to start paying me as soon as possible.

• If I wait they’ll change the rules and I won’t get what they’ve promised.

A bird in the hand is very compelling. Especially when “the bush” is Congress who seems fond of changing the rules and has also not fixed the Trust Fund problem.

Personally I find the “I don’t want to leave money on the table” argument applies equally to waiting vs taking the money sooner. The goal for me is to maximize the benefit I receive, and if I wait and live as long as they expect I’ll be better off.

Break Even Point

One way to look at deciding between taking benefits at age 62, 67 or 70 is to figure out what date you’d catch up and start receiving more by waiting. Obviously if you die while waiting you’d be better off if you started earlier. And if you live 120 years, you’d rather have 30% more benefits for 50 years instead of starting 8 years earlier.

Let’s look at my situation simplified a bit. At 67 my Full Retirement Age, assume my benefit would be $100. If I collected at 62 I’d only get $70. And if I wait until I’m 70, $124. Let’s look at how much I’d receive for each of these choices until I’m 84:

So if I die at 79, I’d have received the same amount if I started at my full retirement age or early at 62. If I waited to collect until 70, I’d break even at 82.5 years. Note that since the benefits are adjusted for inflation we can assume they’re all in “real dollar terms” as of present day. A dollar on the 62 row is worth the same as a dollar on the 82. So we can freely add and compare them.

Let’s zoom in on a few particular years to compare our choices.

If I die at 70, collecting at 67 would mean I’d get 46% less benefits. But if I live to 85 it’d be 12% more.

If I die around 80, it’d kinda not matter a lot if I started collecting early or late. That’s around the break even age.

If I live to 90, I’d collect 17% more if I waited for my full retirement age, and 27% if I wait until 70. At 100 it’d be 24% and 40%.

Life Expectancy

In making this decision, let’s look at how long I’m expected to live. This depends a lot on how long I’ve already lived, obviously someone that’s already 100 is likely to live longer than someone born today since he already can’t have died before 100.

I included stats for my wife, as women tend to live longer than men. 2

So if I make it to 65, I’m expected to live another 17.48 years, dying at age 82.48. If I was a woman I’d be expected to live until 85.12.

Because I’m married I included the joint expectation that either one of us lives as like a light with two bulbs can be expected to provide SOME light longer than a single bulb will. Insurance firms publish these tables, and they are a bit particular as it depends in part on the age of both spouses. My wife is two years younger, so if I’m the oldest survivor I’m expected to live to about 93, but if it’s her, only 91.

Finally, to throw a bit more handwringing into the mix: the above tables are based on the average American. While they take into account sex, they neglect the correlation of wealth with health. I wrote about that in this substack so won’t belabor it here. But it’s an important to know both my wife and I are likely to live a lot longer than average.

Strategy

I turned 62 last year and although I’m retired I have decided to wait until I’m 70 to collect social security benefits. I’ve been lucky and am in reasonably good health, have enough money saved to wait to collect and all of the above actuarial calculations strongly suggest I’ll live beyond the break even point for collecting social security benefits earlier.

When my wife turns 62 in a year and a half we will likely come to a similar conclusion. But it’s also possible that we’ll decide it’s better for her to take contributions early. In that situation, we’d receive her benefits while both of us are alive, but only mine after only one of us is. As we have similar contribution histories the primary differences comes from me just being older as well as being more likely to die younger. If I live to 83 we’d be better off if we both waited. If I die before then, she could live another ten years and receive my higher benefit.

Personal Decision

If you have enough other assets, or can continue working you should carefully decide when to start collecting social security. Many start at 62 but that is probably not optimal for many if not most of them.

If you’re lucky enough to be married you need to consider the additional spousal and survivorship benefits. Note that these are complicated and you are best off looking into your particular situation rather than taking more general advice off the internet. The social security administration agents understand your options and are experts in explaining them. Call them to ensure you do to.

Also, social security is important to your retirement but it’s best to consider how it integrates into your other assets. You might want to consider delaying benefits to make more room for Roth conversions and estate planning if that’s something you’re considering. More articles about those to come on that.

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You’ll hear many different things quoted as interest rates but it’s important to know about their differences. Sometimes these are substantial. Popular assets have a lot of investors buying and selling them so market prices change all the time. Sometimes slowly over time but oftentimes quickly. Spiky prices come with jumps in news coverage.

A fundamental economic assumption is that investors will demand a higher return for a riskier asset than a safer one. This risk can come in many forms, some related to the duration of the loan others to the credit worthiness of the borrower. Let’s list a few assets starting from the least risky and hint at why they’re talked about:

Fed Funds Rate - this is the interest rate charged by the Federal Reserve Bank to banks who need to borrow money overnight. They’re required to deposit a certain fraction of their assets with the bank to ensure they have enough sufficiently liquid assets on hand. When this rate goes up banks are less likely to make loans. It also signals to the world that the Fed believes the economy is strong enough to support employment without more loans. And the Fed is worried that without cutting loans inflation might grow to unacceptable levels.

T-Bill Rate - Every week the US Government borrows money for 91 days. You can buy a treasury bill for $99.50 or so and they will pay you $100 in three months. Many investors like these as they are easy to sell and are relatively insensitive to changes in market interest rates as they mature quickly. It’s used as a bell weather for short term interest rates.

Treasury Yield - this is the current yield on the ten year bond most recently issued by the US Federal Government. It’s very popular as well, and considered free of default risk. Many regulated entities like insurance companies and pension funds are required to invest in these. Foreign governments and bank often invest in them as well. When people say “Bonds” this is what they meant.

The US Government has over thirty trillion dollars of debt. Although the bulk is held by other elements of the government and US companies/institutions, 25% is owned by foreign governments and entities. While generally buying and holding, there is a very active market in trading them and most of the debt is immediately refinanced when it matures. Meaning when the Bank of Japan’s treasury bonds mature, the US Government will send them the redemption value (say $1,000 plus $20 of interest) the BOJ will often simply buy another newly issued bond with the money. The stability of the US Economy as the world’s richest country makes its bonds very liquid and desirable.

These bonds are considered free of default risk - buyers assume they will definitely get paid back. And so naturally form a base level over which other riskier assets are priced. While JPMorgan or Microsoft debt is considered safe, it’s inherently LESS safe than the US Government. So you’ll often find other assets quoted as spreads over the risk free rates. Meaning a corporate bond trading at 7% when the ten year US Government bond is at 4% would be quoted at a spread of 3%.

Note these spreads are often quoted in terms of Basis Points or BPs which are essentially 0.01% (or a percent of a percent). so 25 bps are 0.25%.

While US Govt bonds are free of default risk they’re not impervious to changes in the market demand interest rates. As inflation fears rise investors will generally demand a higher interest rate to buy new loans. They can also change if the economy becomes less stable. The demand for a safe investment can also create a “flight to safety” where investors sell risky assets to buy treasuries, making bond prices rise (and hence the inversely related yields fall). Similarly when worries ease, yields might rise. So owning risk-free ten year bonds isn’t really without risk.

Commercial Paper (aka CP) - short term corporate debt from a major corporation. Apple, Microsoft and Google have large cash positions and when financing their activities will often borrow money over a short period of time to avoid paying the higher interest a long term debt would require.

Muni Bonds - bonds issued by utility companies like electric, solar or water companies or local governments borrowing money for equipment or to build infrastructure like schools, roads or bridges. Often there is underlying collateral or a source of revenue like tolls from bridges or roads backing the bonds. As the bonds are usually free from Federal Tax (due to constitutional law) the yields are usually a fraction of otherwise equivalent debt from the Federal Government. Often the implied default risk is real but minimal.

Mortgage Backed Securities - There are two quasi-government agencies that have an implicit backing from the Federal Government that guarantee mortgage loans. They buy individual mortgages from banks that issue them, combine them into bonds with other loans of similar characteristics and sell them as bonds, guaranteeing they’d be repaid. The primary risk is that the underlying loan will be prepaid when it’s sold or refinanced.

Asset Backed Securities - companies might issue bonds backed by physical assets like commercial airplanes or baskets of loans of credit card debt or car loans.

Corporate Bonds - bonds issued by corporations. Usually ten years or shorter maturity. Pays a higher yield than the equivalent from the US Treasury. Sometimes with odd features like the ability for the issuer to pay the bond off earlier (callable).

Prime Rate - the government collects statistics on the rate banks will extend to their best “prime” clients for unsecured (aka uncollateralized) loans. The average is reported as the prime rate.

Junk Bonds - Corporate bonds that have significant default risk. There are a few agencies that rate the likelihood of bonds defaulting. Note that even in a default there is often residual value as a company goes through the bankruptcy process.

There are also some international bonds that are often mentioned in the press:

Japanese Government Bonds (JGBs) - Like ten year treasuries but historically with much lower yields. The inflation in Japanese Yen and the interest rates have been so low for the past several decades that sophisticated investors borrow in Yen to finance buying assets in high rate currencies (often dollar or Euro). The idea being that they can borrow Yen, convert to USD, buy a USD asset, own it for awhile, then sell it, convert USD back to Yen to pay off the loan, paying less interest than if they did the transaction in USD. This is known as the carry trade.

German Bunds - The German Government has very conservative finances backed by a strong wealthy economy. Often investors will buy them at very low yields. During certain times their short term bill rates even became slightly negative as banks found the convenience of storing their Euros with the German Central Bank made it worthwhile for them to pay for the pleasure.

As mentioned above, when prices of existing bonds rise, their associated “yield” falls. And the reverse happens, if the price falls the yield rises. To understand this, consider that the interest coupon rate of an existing bond will NEVER change. So, if you’re looking to buy a bond that pays $4 per year in interest, if yields are trading at 4% you’d happily pay $100 for the bond. But, if you owned that bond and newer bonds were paying $5 in interest, you’d have to sell your bond for less than $100, as someone with $100 would rather buy a new bond paying more interest than yours.

If that’s confusing, or you’d like to learn more about bonds: Check out this substack

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Investment Policy Statements

You could call these a “financial plan” instead but the point is to give guidance to someone who is looking after your investments. Even if you do that yourself it’s a great idea to think through what you’re after and what you need. Providing a bit of structure and what to consider can help the process.

Individual Stocks are risky

While the whole stock market is a really good investment, focusing too much on a few stocks is very risky. John Bogle said “Don’t look for the needle in the haystack. Just buy the haystack!” Or as quants would say: stock returns are skewed. It’s not a bad thing once you understand what they mean.

Let's talk about Options

I can’t bring up quants without writing something about options. They’re a great tool for some but lousy for many. This explains why.

Trade Craft - Make Time and Volatility your Friend

While you want to invest your money as soon as you can, sometimes a small amount of patience (not too much - the market generally goes up over time so don’t wait for it) can help your returns.

Trade Craft - Tax Lots

If you buy an asset more than once at different prices it can help you manage your taxes as well. This explains some of the nomenclature and helps make sense of it.

Private Equity

There’s a lot in the press about Private Credit and Private Equity so I wanted to write something. Another warning basically, especially useful if you watch “Wall Street” and think Gordon Gecko is the hero.

My version of the Prodigal Son Parable - the investor and the debtor

There’s a lot of divisive talk about class warfare. Before we decide to eat the rich we should figure out if they really will taste good.

Thoughts to Ponder before your love of F1 Costs You.

We should invest a little bit of time thinking about what we’re buying when we drive fast. The speedometer isn’t a measure of where we’re going.

End of Year Tax Moves

Useful things to consider in November/December. Feel free to read it now though as a refresher.

Maximizing your Retirement Contributions

If you’ve contributed the maximum to your 401k/403b, a “backdoor” Roth is your best option.

Trust Asset Allocation and Distributions

For those lucky enough to have a bit of control over what a trust invests in, considering not just the investment results (which are always the priority) but also what income they’ll make available after expenses is a great idea.

Inheriting a Trust

Similarly aimed at those blessed becoming a beneficiary of a trust, there are a few arcane technical tax rules that might help you save money.

Trump Accounts - a couple of articles

Last year the president announced a new type of investment account aimed at young kids. There is still a lot that’s not finalized but they have some very compelling features. Other accounts are also of use so I wanted to help sort them.

More general ideas for investing for young kids

Earlier description when Trump Accounts were just announced

About me (or at least why you might consider my thoughts)

I’m not trying to give explicit financial advice because it’s hard to do that well without understanding the particulars of your situation. But I do want to help you understand something about your options for personal finance and how to consider them to benefit you and your loved ones.

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If you use TurboTax (either online or the desktop version) it’ll offer to file that form for you along with your taxes. If you have an accountant do this for you, it’s probably a good idea to ask them to ensure they’re doing the same for you. There’s no additional data required as you probably already include their ss numbers when declaring them as a dependent. Of course details are still to come so don’t take my word for this, but I would imagine it’ll be easier to take advantage of this program if you file the form now so you don’t have to wait for processing when July rolls around.

While a lot of people have touted a Trump account as great for a number of reasons, I think that $1,000 should certainly draw every parent of a recent child to join the program. Otherwise it’s essentially a way to set up an account like an IRA for your child that doesn’t have earned income.

How does a Trump Account work?

In addition to the initial $1,000 contributed for new babies, you can open an account for anyone younger than 18. In some areas wealthy folks are also offering to kick in (Michael Dell is offering $250 for babies from certain zip codes I think). In addition to these gifts, you can contribute $5k a year to the account. The account must be invested in a broad US stock focused ETF/Mutual Fund. When the child turns 18 it becomes their money, essentially as a traditional IRA that can be rolled into a Roth. They’d owe tax on the earnings if they did that but the contributions would be tax free. It appears the usual IRA rules would apply - you can withdraw for buying a home or educational purposes without penalties but would have to pay taxes on earnings (unless you’ve already paid taxes when rolling into a Roth).

So in short - it’s like contributing post tax money to a traditional IRA. The advantages area the $1k kicker for new babies and that they would otherwise need earned income to contribute to an IRA. Hard for my 8 month old grandson to find work, the slacker.

I thought it was for College/Education?

Well, the funds could be used for education but it’s not as good as a 529 plan as there is no tax on a 529’s earnings used for education. Also some plans like nysaves.org provide a NY State tax deduction on top.

And 529 assets are deemed as “parental” assets not the student’s. So having a Trump account will hurt financial aid more than funds in a 529.

When my grandson goes to college will universities be able to bump their tuition by an extra $1k because they know the Govt gave that to him?

I thought you could start a business?

For that you’d have to pay a 10% penalty as well as taxes on the earnings as ordinary income. Compare that to contributing $5k a year a UTMA investment account invested in an ETF paying 1.2% dividend yield like the S&P 500. If that was their only account, the dividends would be less than $1,350 for the first ten years so they’d pay no taxes on them. After the account broke $100k or so they’d have to pay 10% on the excess but that’s still rather low. When they turned 18 they would not pay taxes on the contributions NOR the dividends, just the capital gains. If they spread those gains over a few years they might avoid taxes completely on the earnings. Which is much better than the Trump account where they’d pay as if all the earnings were ordinary income.

So it’s really a retirement account for babies?

Yes, at least it seems that way to me. It’s an account that turns into the traditional IRA at 18. That’s the perfect age for rolling it into a Roth IRA as their income will be low while starting out. Especially if they stay a student or get additional training so can’t work full time.

As per above, other existing accounts are better ways to finance education or business. A Trump account shines for retirement (or estate planning - for a wealthy grandparent today or even for your new baby when they die and his children inherit the account).

Another important benefit is to get your kids thinking about saving and investing. While gilding their nest is helpful this is a great way to ensure they plan and save for their future.

Why is it a “Trump” account?

Yes, he is a quiet and shy man so it’s very surprising?

Note that there are several retirement accounts named after their sponsor: Keough plans, Coverdell plans, and my favorite Roth are all examples. At least calling it “Trump” might discourage Republicans in congress from changing it for the worse.

Conclusion

For now I think it probably makes sense for parents to fill out the 4547 with their 2025 taxes just to have the option, as well as the chance at $1k from the Treasury. I strongly suspect that once July 4th rolls around we’ll know more about the accounts, and certainly the rules might change to make them better. For now they look rather compelling for non-educational giving.

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Limits

While you can contribute to a traditional IRA, you can’t deduct it from on your income tax if you make too much (for individuals: $150k in 2025 and $153k in 2026, for marrieds $230k in 2025, $242k in 2026). You can keep track of your contribution to avoid paying taxes on it again when you take it out, but the earnings will be taxed as per usual. So there’s little advantage for the money to be in an IRA.

You can’t contribute directly to a Roth IRA at all if you make too much money. The complicated rules (for Traditional IRAs to) are available here at E*Trade. The IRS hasn’t updated their version yet. Check those out to be exactly sure how this applies to your situation.

The loop holes

This does leave us with a neat treat that I’ve used for my wife and me to add quite a bit to our Roth IRAs. The idea is to make non-deductible contributions to a traditional IRA and immediately convert it to a Roth IRA. Since we don’t otherwise have any traditional IRAs (my wife’s traditional 403b doesn’t count) there are no taxes due. The end result is the same as if we had contributed directly to the Roth IRA.

The Details

1. The first step is to create a traditional IRA at my broker (E*Trade this year). I do this for both my wife and myself.

2. Once it’s set up, I make two contributions to each. If I do this in February 2026 the IRS allows me to make a contribution for 2025 as well as 2026 at the same time. I find this useful as it means I only need to do this process every other year.

3. I wait for the funds to arrive in the new account, and then immediately fill out the paper work (online with E*Trade) to convert the IRAs to Roth.

4. When I file my taxes next year for 2026, I’ll note that I made $8,000 non-deductible contribution for 2025 and $8,100 for 2026 to each of the two Traditional IRAs. TurboTax will calculate no tax due when the two $16,100 Traditional IRAs were converted to Roth.

5. The end result is an extra $32,200 in our Roth IRAs.

Why It’s Better

Imagine you have an extra $14k to invest after maxing out your 401k and make too much money to contribute to a Roth, and have no traditional IRA. Say you invest for a long time and your investment doubles when you reach retirement. You have three options:

1. Do the above stuff and end up with 14k in a Roth, that doubles to 28k you can use tax free when you retire.

2. Put the money into a traditional IRA as a post-tax contribution. If it doubles when you retire you can take out your original 14k without taxes, but the earnings of 14k are taxed as ordinary income.

3. Put the money into a brokerage account. Over time it doubles, only the earnings are taxed, but at the capital gains rate.

So #1 is best. #2 is the worst. #3 helps a little bit on taxes but not as much as #1.

Notes

This only works because neither I nor my wife have a traditional IRA. That allows us to allocate all of the money in the conversion to the IRA that has only post tax contributions. If we had another IRA that contained pre-tax money the conversion would be taxed as prorated from both IRAs.

Finally let’s make it plain that Roth might be your best choice for saving money for retirement. There are more details in Roth vs Traditional IRAs.

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There are three major ways people buy stocks (aka equities).

One of the best is to purchase broad market Exchange Traded Funds (ETFs) that are linked to specific benchmark indexes like the S&P 500 (ticker SPY, IVV, VOO) or the All Countries World Index (ACWI or VT). A single position lets you invest in hundreds or thousands of companies at once. I make extensive use of these, especially in retirement accounts where taxes aren’t a concern (meaning mistakes/losses can’t be used to offset taxable gains in other investments).

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You can also research into individual company’s finances and businesses and decide one’s current price is significantly less than it will likely be in the future. So you buy it in the hopes that the rest of the market will eventually agree with you and raise it’s price. Sometimes that happens over time, or you might change your mind and you’ll sell.

In both approaches you’re buying a part of a hopefully profitable undertaking and waiting, potentially for years for it to bear fruit. When things do work out, waiting for a full year might lower the taxes on the capital gains. So the government encourages you towards this view of investing for the long term. Buy and hold. Day Trading is different.

Day Trading involves buying and then selling the stock all in a single day so overnight you don’t have a position that requires funding. The goal is to find a stock that you think can be bought now and sold at a profit in a few hours, minutes or even seconds. As overall stock prices tend to rise over time this seems like a tractable vocation. And it’s not hard to find people that manage to make a lot of money by doing it.

Day Trading Pros

Little capital needed - you can start day trading with just a couple of hundred dollars. You’ll need more to take bigger risks of course. If you exhibit “day trading pattern” the brokerage firm might require $25k of cash. But some exchanges (especially those trading crypto) will stake you for as long as you have at least some money to start (or left in your account).

Can do it anywhere - you can trade from a beach (like my accidental foray). All you need is a phone with an internet connection. You don’t even need to get out of your bed.

Little Time Needed - you can start trading at 9:30 EST (or earlier in some markets) and stop half an hour later if you want. You can also do it around the clock but we’re talking about “pros” here.

Sleep Easy - Overnight you’re not invested so no worries about the market moving against you.

Potential for Big Gains - if you get lucky you can parlay a modest amount of money into a big fortune.

Day Trading Cons

Fierce Competition - there are innumerable hedge funds with experienced professionals taking the other side of your bets. They have really smart computer programmers and quants armed with vast computing facilities.

You’ll pay the spread - To get in and then out you’ll need to pay the bid/ask spread. That can add up if you trade a lot.

You miss the big news - The market generally tends up, and a lot of that happens after the market is closed for the day when you’re not carrying a position.

You’re money isn’t working for you - When you invest your money is working hard to earn for you. The expected return from investing in stocks is MUCH better than the interest you’ll get on the cash in your account. Hopefully you’ll beat inflation but probably not by much.

Adverse Tax Treatment - any profits are taxed as ordinary income, not at preferential long term capital gains. No dividends are accrued as you are never the owner of record for any shares overnight. Wash sale rules might make calculations difficult if you buy the same stock within 30 days of realizing a loss.

A bad streak will wipe you out - while you don’t need a lot of capital to start you do need to never lose everything. All you need is a few big enough losses in a row to leave you with nothing (or even slightly less if your broker is too tolerant).

You’re Human - There are several emotions we all have that will need constant taming:

1. Making it personal - after a loss you’ll want to “beat” the market by increasing the size of your bet to prove you’re right.

2. Waiting too long when you should cut your loss - it’s hard to admit we’re wrong. Waiting “just a little longer” might be throwing good money after bad.

3. Believing in false patterns - clouds can have pretty shapes but they eventually fade into wisps or storms.

4. Trusting in providence - God might love you but the market is neutral at best.

5. Falling for Traps - If you detect a pattern, there’s a chance a computer put it in place for you to find and is waiting to trip you in its snare.

Survivor Bias - if enough people try this some will get really lucky and stop after making a lot of money. There are many more empty bank accounts for every finance bro bragging on social media, they’re just a lot quieter about the results. I assume you know the loud mouths shilling their $99 seminar on how to do this aren’t to be trusted.

Day Trading is speculation

Day Trading is not investing in a profitable enterprise, rather it’s a betting stock prices will fluctuate in a way that will make you money. If this was a reliable endeavor there are a lot of people working for a number of well capitalized firms who would have found it. It’s much more likely that whatever money they’re making is by taking advantage of the never ending supply of people who try day trading. I recommend you stay away.

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