The problem with tax deferred investments

If you’ve read much about investing or financial planning, you’ve heard the mantra about investing in tax deferred plans.

These plans come in many different forms (traditional IRAs (Individual Retirement Accounts), Roth IRAs, Simple IRAs, SEP IRAs, 401(k)s, Roth 401(k)s, Thrift Savings Plans, etc.), but they all provide the benefit of tax deferred savings.

For most investors, the problem isn’t understanding why tax deferred plans are a good idea, but in selecting what to do with the money they’ve put into these plans.

Most investors don’t even invest in these plans, frequently because they are overwhelmed by the options.

Many leave it in low returning money market accounts or chase the performance of the most recent “winners,” both ending up with poor returns, but for different reasons.

When my clients come to me with lists varying from 25 to 900 options, their question is always the same, “where should I put my money?”

I’ll admit right off, the answer isn’t easy. Because I make my living focusing on investments, I know how to pick good money managers. But there’s no reason to expect everyone to know how to do this.

When a plumbing leak occurs in my house, I call a plumber. When my car needs its timing belt changed, I take it to a maintenance professional. But, most people try to make the choice of where to invest their money on their own.

They usually ask a friend or relative, because they can trust such people. The problem is that they may end up with the blind leading the blind. A person can be trustworthy and still not know what they’re talking about. I wouldn’t ask my dad to change my timing belt unless I thought he knew what the heck he was doing.

The problem is that picking a money manager is notoriously difficult. A whole profession of consultants has sprung up to help people make this choice. Most of them, unfortunately, are paid commissions to sell certain funds. Others are entranced by the mathematical analysis of short term performance, which has the same utility as examining goat entrails.

No, the best way to find a good money manager is to ask a good money manager. Good investment managers tend to watch what other money managers do, and they have to spend a lot of time figuring out who is really good and who is just lucky. Because I’m in the field and follow the best managers closely, I know who’s good and who isn’t.

The secret is to watch their process. If you just look at their results, you may just be seeing luck. Even 20 year records can be built on sand if their process is flawed. If you had asked the folks in New Orleans about the levy before and then after Katrina, you would have heard two very different opinions. Past performance is no guarantee of future results.

If their process is sound, the results will take care of itself, even if their record doesn’t look great in the short term. In the late 1990s, a lot of money managers were dumped because “they didn’t get the ‘net.” Look at their records now and you’ll see that process is much more important than a 1, 3 or 5 year records, especially if you’re investing for the long run.

To solve the problem with tax deferred investments, people will have to spend more time either learning how to pick managers, or in finding people who can pick managers. I think the best approach is to ask investment managers who are good investors themselves, and to focus on process over results.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.