BreadWithSpam[at]fractious.net wrote:


- quote -

This is a recurring topic, in a roundabout sort of way.
When asked "what do I do with my next $1000 of long term money?" we tend
to reply;

1) Fund 401 to matching point
2) Pay down high interest loans
3) Fund Roth
4) Fund 401 till full
5a) Invest in diversified mix.
5b) accelerate mortgage payments

I use a/b for 5, as depending on the mortgage rate it may be more or
less favorable to pick one over the other. While the exact order of the
above may depend on many factors, it's obvious to me that doing 5b
before 1-3 is likely a mistake. But it doesn't surprise me that this
happens everyday and in great numbers. A total US cost for this
mis-allocation of $1.5B surprises me, only that it's so low. This is
$5/person in the whole country.
Joe
JOETAXPAYER.COM

Another interesting data point.

Thanks to Greg Mankiw's blog for the link.
http://gregmankiw.blogspot.com/2006/...your-401k.html

It is interesting that they point out that it's specifically
a *tax* arbitrage. I may buy the paper (it's only $5) to
see how they come up with this and if they address expected
returns on the investments themselves in any way.

--snip--

http://papers.nber.org/papers/w12502

Gene Amromin, Jennifer Huang, Clemens Sialm

NBER Working Paper No. 12502
Issued in August 2006


We show that a significant number of households can perform a tax
arbitrage by cutting back on their additional mortgage payments and
increasing their contributions to tax-deferred accounts
(TDA). Using data from the Survey of Consumer Finances, we show
that about 38% of U.S. households that are accelerating their
mortgage payments instead of saving in tax-deferred accounts are
making the wrong choice. For these households, reallocating their
savings can yield a mean benefit of 11 to 17 cents per dollar,
depending on the choice of investment assets in the TDA. In the
aggregate, these mis-allocated savings are costing U.S. households
as much as 1.5 billion dollars per year. Finally, we show
empirically that this inefficient behavior is unlikely to be driven
by liquidity considerations and that self-reported debt aversion
and risk aversion variables explain to some extent the preference
for paying off debt obligations early and hence the propensity to
forgo our proposed tax arbitrage.


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