Why Henry Blodget Tries To Make Saving A Sucker’s Game – And Why You Shouldn’t Believe Him

Argument and debateHopefully that title got your attention. In fact, it’s a variation on the subtitle of an article posted to Slate.com yesterday, Spend Every Dime!, which says that you’ll actually lose money by saving and investing it, so why not spend now? Normally I would ignore such tripe, but this article has been making the rounds on several popular sites and multiple readers have asked me about my perspective on the article, so here goes. It won’t be pretty.

Unsurprisingly, this article was written by Henry Blodget who, along with Mary Meeker, was one of the investment analysts heavily behind the dot-com boom – and he paid dearly when it went belly-up. The end result? He lost his job at Merrill Lynch in 2001 and in 2003 was was charged with securities fraud by the SEC. He’s currently banned from the securities industry for life, which leads us to his career as a writer at Slate, where he basically spends his time slamming the securities industry.

Now that we know who is writing this stuff, let’s take a closer look at it. Here’s the key paragraph, in which he “explains” why saving is a fool’s game:

How does the math work? Let’s say your T-bills return 3.7 percent. If you stash $10,000, you’ll make $370 before taxes and inflation in the first year. Taxes are assessed on the nominal gain (before adjusting for inflation) instead of the real gain, so if you’re in the 15 percent tax bracket, you’ll then pay $56 to the government—and lose about $310 of value to inflation. In other words, you’ll eke out about a $5 real gain on a $10,000 investment (an 0.05 percent return). If you’re in higher brackets, meanwhile, you’ll actually lose about 0.5 percent of value every year. The only time you’ll generate real gains is when “real” rates of return are significantly higher than 0.6 percent (as they are now). But when real rates are negative, as they were a few years ago, you’ll be losing a lot more than 0.5 percent per year.

In other words, his argument is that if you put money into a 3.7% T-bill right now (here’s my earlier article explaining what a T-bill is and how it works), you’ll basically break even in “real value” over a long period, because inflation plus taxes will eat your gains.

Problem number one is that your other options are far, far worse. Let’s say you instead stuff the cash into your mattress. With inflation at roughly 3%, if you leave that one dollar in your mattress for ten years, it will only have the purchasing power of 74 cents while if you leave it in the T-bill, that dollar will keep its real value over the ten years. Even worse is when you spend that money now. Almost every consumer purchase you make starts depreciating immediately as soon as you buy it, making the actual spending of the money quite terrible.

In other words, Blodget is using a debate technique: argument by selective observation, also known as “cherry picking.” He’s applying a set of facts to the T-bill, but not applying it to the default state, cash.

Problem number two is the way he treats the stock market:

Unlike T-bills or bank accounts, stocks compound tax free, so you won’t owe tax until you sell them (except, again, on the dividends). Yet even stocks aren’t ideal for savings. For one thing, there are those annoying bear markets: The S&P 500 is still below where it was seven years ago, even before adjusting for inflation. Then there are dividend taxes: In the 20th century, nearly half of the average 10 percent annual return on U.S. stocks came from dividends, not price appreciation, and you pay taxes on dividends every year. Lastly, there’s the absurd way that the IRS accounts for “realized gains.” Once you’re in the black on a stock or fund, current tax policy forces you to stick with it—or get socked with a capital-gains tax bill. In other words, even if your stock’s best gains are behind it, if you switch to a better stock, it might be years after paying your tax bill before you get back to even.

This is utter madness. Capital gains tax on dividends does occur, but it’s capped at 15%. In essence, you collect a dividend of $100 – money paid out to you directly by a company without you having to get rid of any of your assets – and you only have to pay $15 on it. That’s significantly lower than the income tax that you have to pay on money you earn from working; if this dividend were treated that way, you’d likely have to pay $28 of it to Uncle Sam. In short, compared to actually working for a living, stock dividends are a very tax-effective way of generating income.

Here, Blodget uses argument by generalization: income that is taxed is bad. Dividends are taxed. Thus, dividends are bad. That’s a terrific fallacy.

Problem number three is that he spends most of the article blaming the tax man for this when the real enemy of any investment is inflation. Inflation eats the majority of your gains on most investments, but it’s an invisible monster: you don’t directly see it on the balance sheet. You only see it when you go to the store and realize that your money doesn’t buy as much as it used to.

This time, Blodget uses my favorite debate fallacy, the fallacy of the general rule. “Uncle Sam takes our money via taxes. Why would he leave us broke like that? Let’s spend instead!” and thus preys upon irrational mistrust of the government in a case where the government actually does a really good job of looking out for individual investors. The truth is that Uncle Sam only takes a small portion of the pie: the real monster in the room is that of inflation, and via the Federal Reserve, Uncle Sam is doing a very good job of battling that monster. In short, Blodget has an axe to grind, and he’s using bad debate techniques to push his viewpoint.

Here’s the truth: over the long run, saving beats spending any way you look at it. You can construct situations where saving doesn’t earn huge returns, but if you use those same glasses to look at spending the money (or even stowing it away in a mattress), those other options are far, far worse. Don’t let some fool with an axe to grind convince you to spend your money irrationally.

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  1. plonkee says:

    If you think of spending as in fact investing in stuff (which it is), then its trivially easy to show that spending on things that don’t hold their value (like a tub of ice cream) leaves you less well off than putting the money under your mattress, let alone saving it.

    Its true that when you are investing you are taking on more (and different) risk, but its actually relatively difficult to invest in something that will lose you your entire cash investment as well as a tub of ice cream will.

  2. Michelle says:

    In the old days, people had a choice. They could eat all of their garden produce in the summer and autumn, or they could pickle some of it for the long winter.

    Unfortunately, the pickled food didn’t taste quite as good, and some of it spoiled in spite of the pickling.

    Gosh, weren’t they silly for pickling their food? They would have been so much smarter to eat it when it was fresh!

  3. James says:

    Be careful thinking the Federal Reserve is doing *that* fantastic of a job keeping inflation down.

    Inflation within our country’s borders may be kept at that 3% mark we all know and love, but the dollar is getting weaker…down >10% vs the pound and the euro in the past year. So really, you could’ve exchanged some American money for Euros, stuffed THAT under your mattress and made a healthy return over the last year…tax free.

    As humorous as that idea may be, it is a serious concern given today’s global market…ie we import a lot of things and are now paying more dollars for those things.

  4. Eric says:

    On a similar topic I have seen people, recently, advocate that saving for children’s college hurts them! They claim that not saving will increase their children’s ability to get need based scholarships. They also somehow believe that if they don’t want to pay for college that the government will somehow change the aid formula just for them.

    It’s a similar dytopia to what you are complaining about.

  5. Mike says:

    Some of those folks at Slate.com are a very nutty bunch.

  6. sean says:

    A bit on exchange rates:

    If our currency has depreciated with respect to the euro and pound, our imports (from Europe and England) should begin to reduce in number. From the American point of view, European goods will seem more expensive then they were with the more favorable exchange rate. This will cause American consumers to begin looking elsewhere for their goods. Additionally, this will also increase European imports of American items. It’s somewhat of a self-correcting mechanism, theoretically speaking.

    More importantly, most of our imports come from Canada, Mexico, China, and Japan. Our exchange rate with each of these countries should be the true measuring stick. If the dollar has depreciated versus all four of the above nations, we should see total American imports begin to decline.

    That being said, I agree that exploiting exchange rates for financial gain is an effective strategy.

  7. Amy says:

    You may be calling Blodget out for cheap debate tricks, but you’re hardly above using them yourself, starting with the ad hominem attack at the beginning of your post. Then you engage in some cherry-picking yourself, nitpicking arguments against ascribing too much weight to taxes on dividends and suggesting that T-bills are a good investment because they beat cash under the mattress, without addressing the main thesis of his argument.

    Furthermore, you appear to lack understanding of how an economist conceptualizes spending. Money is not the end product, maximizing utility, broadly understood, is. We save for the future not to get more money, but to ensure that we have money to continue to transform into a utility stream throughout our lives.

    Blodget’s thesis is essentially that simple investments barely break even over time because of taxes and inflation, while other investments are often too complex, too costly, or too inflexible to be of use to many Americans. He suggests that creating a more accessible, tax-advantaged savings vehicle would have a positive impact on the savings rate. Would you care to disagree with this?

    Incidentally, the authors of Slate pieces don’t choose the titles of their articles, the editors write them with an eye to maximizing clicks. So there’s often a mismatch between the title and the thesis of the article.

  8. Benji says:

    What I find it so amazing that these dot-com crooks gain employment so easily in the circles of modern day socialists.

    The founders of Moveon.org’s founders are a prime example.

  9. js says:

    If the rate of inflation is greater than the after tax rate of return on investment then spending is better. Whether this is the case, is an empirical matter.

    If it is also the case that the stuff you buy is losing money even faster than your money, then it still doesn’t make saving a good choice. In that case instead you should spend on assets that don’t lose money – housing, gold, or spend it on experiences like travel. If you can buy more travel or basket weaving classes or whatever with $1000 today than $1000 plus interest 5 years from now then might as well do it now.

    I also really don’t understand about capital gains taxes on dividends, some part of arcane tax law I don’t understand I suppose. I thought dividends and capital gains were two different things. Dividends are taxed as regular income, capital gains at 15% (the 15% is not such a deal though when you add to it a near 10% state tax on all income including capital gains, that I’m paying here in CA).

  10. OFten times, it’s a case of vocabulary elitism. SOme people, when hearing terms like “capital gains,” “inflation” and T-bills, automatically assume that the speaker is an expert. They forget to grab the saltshaker for that all important grain of salt.

  11. Trent says:

    Amy, it’s not an ad hominem attack. The only part of Blodget’s background that I discuss is the one that introduces bias in his argument: he has an axe to grind against the securities industry. An ad hominem attack would have been if I had called him an adulterer or something.

  12. ck_dex says:

    Just a clarification: capital gains rates match your federal tax rate if you hold the stocks for less than a year. Ouch, that can be as high as 35%.

    And as js pointed out, some states don’t have a separate lower capital gains rate, so you pay regular income tax rates for the state portion (6.45% in KS). Some states like Mass. do have a lower rate for cap gains (5% last I checked) versus regular income tax. (By the way, I cringe when I here people talk about Taxachusetts–we pay way more in the great red state of Kansas).

  13. Jim Lippard says:

    sean: “So really, you could’ve exchanged some American money for Euros, stuffed THAT under your mattress and made a healthy return over the last year…tax free.”

    If you convert those euros back to U.S. dollars, you do owe income tax on the exchange rate gain–it’s not a tax-free gain.

  14. KMull says:

    Trent,
    Thanks for pointing this out. I had seen the article and … oh wait. Finance advice in Slate. Nevermind. :)

  15. js says:

    Actually some of his advice on how investments in non-tax sheltered mutual funds can cost you a lot of money tax wise is very good (it’s not at all original, but it’s correct nonetheless). But I’ve learned the hard way. I owe, I owe (the IRS and the state), so it’s off to work I go.

  16. Ian says:

    I agree with Amy. Blodget isn’t arguing that you should spend. He’s arguing that current tax laws provide a strong incentive to spend, and that they should be reworked to provide more incentives to save.

    This guy agrees with you.

  17. hanmeng says:

    Yeah, Amy & Ian are right; the thrust of Blodget’s article is that current tax laws are a poor incentive for saving, and so people who don’t save are acting rationally. He is by no means advising people to do this.

    As several of his recent columns show, he promotes long-term, diversified investing:
    http://www.slate.com/id/2161304/
    http://www.slate.com/id/2160236/

  18. Trent says:

    Amy, Ian, Hanmeng: Obviously, lower taxes on savings would be an encouragement to save more. No income tax at all would be great, too. The problem is that it’s not realistic.

    The article is also ignoring the fact that compared to inflation, taxes aren’t eating much of investment returns at all.

    The reason people spend like gangbusters and don’t save doesn’t have anything to do with capital gains tax.

  19. Trent says:

    Amy, you say “Blodget’s thesis is essentially that simple investments barely break even over time because of taxes and inflation, while other investments are often too complex, too costly, or too inflexible to be of use to many Americans. He suggests that creating a more accessible, tax-advantaged savings vehicle would have a positive impact on the savings rate. Would you care to disagree with this?” Yes, I disagree strongly. Taxation as a whole has never been lower than it is now since its inception, yet somehow savings rates are at their lowest point, too? Again, it’s not taxes that are to blame here unless you’re an anarchist.

  20. CMB says:

    Trent,

    I’ve been reading your blog for about six months now, and it’s pretty clear you know what you are talking about. Thus, it is disappointing that you have grossly misrepresented Blodget’s article in the way you did. As Amy and Ian have pointed out, Blodget was arguing for a change in the tax system, not telling people to spend all their money. I have not seen you stoop to name calling and political bickering before-what does it accomplish now?

    Would you care to cite references for the following statements?

    “The reason people spend like gangbusters and don’t save doesn’t have anything to do with capital gains tax.”

    “Taxation as a whole has never been lower than it is now since its inception, yet somehow savings rates are at their lowest point, too?”

  21. Trent says:

    Since the 1970s, the income tax rate has gone from 14-70% (depending on bracket) to 10-35% (depending on bracket), a drastic reduction (see http://en.wikipedia.org/wiki/United_States_Income_tax). At the same time, just since 1990, the savings rate in the United States has HALVED (http://www.oecd.org/dataoecd/53/48/32023442.pdf). To claim people aren’t saving because of oppressive taxes is nonsensical. The numbers show that as tax rates have gone down in the United States, so have savings rates, so it’s a fool’s game to conclude that further tax reductions would increase savings.

  22. CMB says:

    I looked at the OECD PDF link you posted. It states that

    “The household
    saving ratio must therefore be calculated as the
    ratio of household saving (B.8 – SNA 93 code)
    divided by household disposable income (B.6) plus
    the adjustment for the change in net equity of
    households in pension funds (D.8). The United
    States has chosen not to follow the SNA 93
    treatment…Consequently,
    the adjustment item is not required and the
    traditional definition of the household saving ratio
    still applies.”

    And a little earlier
    “The household saving ratio has traditionally been
    defined as household saving divided by household
    disposable income.”

    So basically it is using the NIPA calculation to determine household savings. Even the federal reserve board says that this way of measuring “savings” is flawed:

    “…the NIPA personal
    saving rate gives an incomplete picture of household
    savings behavior. For example, the NIPA measures
    of income and savings exclude the sale of or
    change in the market value of existing assets. For
    financial assets, personal income does include dividend
    and interest income to persons, but excludes
    capital gains and losses.”

    http://www.frbsf.org/publications/economics/letter/2002/el2002-09.pdf

    (Slightly dated, but still useful commentary).

    Savings rates might very well have gone down because the savings that were “waiting” for investment are now invested. Perhaps if the tax rate were lower investment would be higher; perhaps not. Either way, I don’t think either Blodget or you can definitively conclude a cause and effect here based on these simple studies.

  23. Brianary says:

    Are you seriously assuming that the inflation rate is only 3%? I don’t know about you, but the amount I spend for all of the same goods has gone up much more than 3%/year in the last ten years.

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