Three wishes from a financial genie

The issue at hand

Meet our hypothetical individual: a resident of sunny California with an annual income of $150,000. Living in San Francisco, they face a tax rate of 32.2% without any 401(k) contributions and 27.6% when they max out their 401(k). 

They have annual expenses amounting to $80,000, and we're assuming that anything they can't stash away in an IRA or 401(k) is spent. 

Dividends, when received, are reinvested into the portfolio and are taxed as they come in. There's no rebalancing, and tax rates during retirement are assumed to remain the same. And, for simplicity, we're not adjusting any of the inputs for inflation.

Our analysis spans 20 years, from August 1, 2003, to July 31, 2023.

The three scenarios

Below is an overview of each scenario, and how much our hypothetical investor was able to invest each month.

1) Perfectly time the market:

• Investment: VTI
• Strategy: Each month, our individual buys shares of VTI at the lowest closing price. All funds are invested on that day.
• 401(k) Contribution: $0
• Monthly Investable Take-home Income: $1,812

2) Invest like Warren Buffet:

• Investment: BRK.B
• Strategy: Every month, on the first trading day, our individual invests in BRK.B, effectively aligning their investment strategy with Warren Buffet.
• 401(k) Contribution: $0
• Monthly Investable Take-home Income: $1,812

3) Maximize tax advantages:

• Investment: VTI
• Strategy: Max out the 401(k) and Roth IRA each year, investing only in VTI at the start of the month.
• 401(k) Contribution: $938 (per pay period, assuming 2 periods/month)
• Monthly Investable Take-home Income: $506

Crunching the numbers

1) Perfectly time the market:

• Ending Pre-tax Value: $1,456,314
• Ending After-tax Value: $1,328,403
• After-tax Return: 10.1%

2) Invest like Warren Buffet:

• Ending Pre-tax Value: $1,528,440
• Ending After-tax Value: $1,364,681
• After-tax Return: 10.3%

3) Maximize tax advantages:

• Ending Pre-tax Value: $1,920,433
• Ending After-tax Value: $1,502,703
• After-tax Return: 11.0%

The best financial wish

While the allure of perfectly timing the market or investing alongside Warren Buffet might seem tempting, the numbers don't lie. Maximizing tax advantages clearly emerges as the winner, with the highest after-tax return of 11.0%. Not only does this strategy provide the highest pre-tax and after-tax values, but it also underscores the importance of tax-efficient investing.

So, if a financial genie were to grant you a wish, remember that sometimes the most straightforward strategies, like maximizing tax advantages, can yield the most significant rewards. Cheers to smart investing!