Magical Dollars

Dollars are fungible.

They really are — kinda.

When most people hear that phrase, though, their only response is to say, “what’s fungible mean.”

Lawyers learn the word in lawschool, and a few others learn it in their work. But just about no one learns it as part of their daily living.

If you look up the word, you’re apt to see something about how one milliliter of corn oil is the same as every other milliliter of corn oil, so that, if you have seen one milliliter of corn oil, you quite literally have seen what they all look like. That’s what it means to be fungible. It means interchangeable.

So dollars are interchangeable. One dollar is like another is like another is like another. That green thing in your pocket which the germophobe in you might abhor, for instance, is the same as the information kept in clean, beautiful digital form by your bank indicating your ownership of $1.00, and both are the same as the dollar chip someone in Reno, Nevada just shoved down the throat of a dollar slot machine while smoking a cigarette and drinking a cheap scotch.

Rather unlike, say, spouses and kids, right? Loved ones are unique. They are not fungible.

* * *

Classical economists posit that we are all rationale economic beings (at least in the aggregate), and that part of that rationality means that we do not discriminate among different chunks of the same fungible good — we don’t care which milliliter of corn oil we get, and we don’t care which milliliter of corn oil someone else gets.

And, the thinking goes, we should view each dollar over which we have dominion the same as we view every other dollar over which we have dominion.

These days, wouldn’t’ch’ya know it, when it comes to predicting human behavior and the economic outcomes that, both individually and in the aggregate, it generates, classical economists are mostly on the run (their name gives it away, n’est ce pas?). People, it turns out, when serving in their roles as economic actors, making decisions and such, are just not all that rational; instead, they tend to act quite irrationally, and in fairly well-predictable ways.

So, yea, dollars are, in one sense, fungible, but, yea again, most human beings respond well to keeping certain dollars divided out from other dollars.

* * *

As a result, I, as well as most financial advisors, never hesitate to tell clients to view some of their dollars differently from they way they view other dollars of theirs.

For instance, I advise all clients to have a rainy-day-money account, and to have that account set up to be entirely separate from their day-to-day checking accounts and the like.

You have a rainy-day account, don’t you? The general advice is to have a rainy-day-account with at least six months’ worth of your monthly expenses sitting in cash, where you can get to it on a moment’s notice, ready to ably assist you whenever an unexpected nasty comes your way bearing dollar-denominated requirements. And, as long as we’re talking about these things, when clients can afford to do so, I always advise them to have sunny-day-accounts as well, for those occasions when an unexpected pleasure, bearing dollar-denominated requirements, come into their lives.

* * *

Taken to its logical extreme, then, each chunk of your dollars can be stored in a vessel specifically designed for it. Money saved up for putting your kids through college, for example, can be housed in a vessel specifically designed for that purpose (primarily 529 plans). And then there’s the segregated chunk which most everyone knows well, which is the money you are setting aside for your later years — money stored in retirement accounts.

Dollars held in retirement accounts, in particular, are held in highly specialized, very specifically designed types of accounts. I’ll save for another day, though, a discussion of all those different types of accounts. For the time being, I’ll just say that dollars held in retirement accounts are magical; they are not like your other dollars.

The main way the dollars in your retirement accounts are not like all your other dollars is that they have a very specific, and rare, tax flavor.

More specifically, those dollars either (a) have never been taxed, which is rare because you have in fact earned those dollars, and earned dollars are just about always taxed up the wazoo, what with social security taxes, income taxes, etc., exacting their pound of flesh, or (b) have been taxed, but they, as well as all their dollar-progeny, will never be taxed again, which is unusual because dollars begat by other dollars — dollar-progeny — are just about always taxed up the semi-wazoo (“semi” because they are subject only to income taxes, and not to social security, etc. taxes).

From there the specifics of the tax flavors get more and more involved. That is for another day.

For our purposes, it’s enough to realize that the dollars of yours residing inside of retirement accounts are magical dollars due to their unique tax flavoring.

They’re so special, in fact, that the government severely curtails how many dollars you can convert each year into magical dollars. For instance, this year you can put $16.5k into a 401k plan ($22k if you are 50 or older).

The magic, as it happens, is not unlimited.

Otherwise it wouldn’t be magic . . . and the mantra therefore has to be:

Must . . . conserve . . . the magic.

* * *

Now I have broadly railed against money managers in the past, because I think most normal people are better off without money managers, in that they can achieve as good a result (sometimes better) with far less effort by doing their own investing (so long as they do a certain kind of simple-is-as-simple-does investing) (also a topic for another day).

Today’s railing is far more narrow than that — far more nuts ‘n bolts’y than usual.

We start with the fact that almost all money managers charge an assets under management fee, also known as an AUM fee (said out loud as the three letters separately — A U M — rather than as the yogic magical sound of aaaaah ooooooo mmmmmmm). AUM fees typically equal 1% of assets under management per year, calculated as 0.25% of the end-of-quarter balance of the client’s assets held by the money-manager, and typically paid directly out of the client’s assets, as an auto-ding to the account.

Now just about every money manager whose work I have ever looked at takes his or her AUM fees against each account. So each non-retirement account, regardless of size, gets auto-dinged 0.25% per quarter, each retirement account, regardless of size, gets auto-dinged 0.25% per quarter, etc.

But that is, quite simply, often not in the client’s best interests. And having read this piece, you now know why: taking AUM fees out of each account, so that retirement accounts and non-retirement accounts alike are auto-dinged, has the wholly undesirable effect of using magical dollars when regular dollars will surely do.

After all, since it’s hard to get regular dollars converted into magical dollars, wouldn’t it be better to pay the entire AUM fee — for all the different kinds of accounts, all together — entirely from a single account in which the regular dollars reside?

I mean, why spend the magic when you can spend the ordinary?

Hmmm . . .

* * *

So, if you have an AUM-fee-charging money manager in your life, and if your MM is managing both retirement and non-retirement account money for you, then, please, ask your MM whether you are using some of your highly-desired, much-sought-after, quite-rare magical dollars when you could instead be using good ol‘, plain vanilla, totally fungible, corn-oil-like regular dollars, preferably from the non-retirement account with the largest balance.

In fact, why not tell your MM that you’d like to pay him or her with some of those germy green things in your pocket, so that each quarter you can can come in, look him or her straight in the eyes, plunk down your green things, and say, Here’s your fee. What did you do to earn it?, and then sit back and listen to what s/he has to say.

‘Til tomorrow, then, here’s to your overall financial health, and may it continuously improve.

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