Philadelphia Reflections

The musings of a physician who has served the community for over six decades

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Introduction: Surviving Health Costs to Retire: Health (and Retirement) Savings Accounts
New topic 2016-03-08 22:42:53 description

Escrow and/or Escrow-like

There are many times in a lifetime when new opportunities to spend rather than save, appear. You have a little cash and must decide what to do with it, for example. This choice presents itself with every paycheck. We suggest an automatic paycheck deduction is the best way to handle it. Big specific temptations also come up. Your neighbor buys a new car, and you reflect whether it is your time for a bigger car, too. You are therefore tempted to make a big withdrawal from a retirement account to pay for it. Bad idea, don't do it. On the other hand, maybe you smashed up the old car and must have a way to get to work, so you do it. You want a way to resist big-ticket temptations, but you must not close that door entirely. We suggest an escrow account.

An "escrow" is a service often performed by a third party for a fee, to hold the two main parties to terms they independently agree on, and can only change if they both agree, or else a judge agrees. Escrow can be a variant of insurance. Please bear with us, for a paragraph or two on this remote subject. Escrow variations in real estate are common, many assume escrow must be limited to real estate. But in an HSA there also arises a frequent need to identify illiquid funds, set aside for some future purpose; the term escrow also comes to mind. Illiquid funds usually command higher interest rates, the "yield curve" is in the daily newspapers, but both parties must agree to change it. Some people are naturally frugal, others are spendthrifts; funds are needed for emergencies, others are saved for later. All that creates a need for what we describe as an escrow account, as distinguished from "demand" accounts; others may call it something else. Since fees are often hidden, let's just say custody account instead of escrow. But remember. Don't escrow yourself into unnecessary fees for a lifetime; do it only for the best interest rate. Words like "prime rate plus 1%" might be used.

Short term investments carry lower interest rates than long-term ones because there is more risk of default the longer the risk continues. Banks survive on the difference (yield) between the rate for them to borrow and the rate to lend; the "spread" varies with the duration of the loan -- overnight, say, or thirty years. The critical issue is the duration of quarantine, but in general U.S. Treasury bills and bonds are found in demand accounts, while common stocks, lines of credit, and other permanent investments must be guaranteed in some way for the duration of investment when their term is not already stated. It's a method of protecting the lender if he pays higher rates, but it's also useful to everybody if life situations change.

Therefore, whether you call it an escrow or not, investors should be given the option of setting certain HSA funds aside were, like Ulysses tied to the mast, they cannot touch the account until a certain time, by common consent, or with a court order. Their broker will respond with a higher investment return if he knows the investment can't be sold "out from under him". Getting back to Health and Retirement Savings Accounts, young people nowadays rarely get seriously ill; old folks often do. If a young investor knows he can ride out the bumps along the way, he is justified in hoping he can get 8% after-tax and after-inflation return. Otherwise, he might be lucky to get 1%. With really long-term investments, even a few tenths of a percent can make a major difference. Let's touch on a few examples.

Squeezing the Lemon Dry. Let's imagine he only spends 1.4% on investment expenses (at age 21); he thus gets back 6.6% on an 8% investment, net of inflation. If he spends 0.1% more on expenses, he will only net 6.5%, or $30,000 less at age 66. That's a lot of money for very little difference in effort, but he should have planned better. We are here suggesting passive investment in the entire stock market, using index funds, no tips, no stock-picking. In a pinch, the higher quality of "collateral" will command somewhat more favorable rates.

"Active investment" or "stock picking by experts" may yield somewhat more for what is judged high-quality assets, although it is hard to see why they should, net of hidden fees. The extra yield is often eaten up by extra fees. And then there is the theory of "black swans", general stock market dips of 30-60%, occurring every twenty or thirty years. The older he gets, the less likely an investor will be, to have time to recover from a "black swan", and the more he needs deflation protection with up to 40% Treasury bond content. But that protection costs his yield another couple percent in fifteen years. To have the funds to manage it, a young borrower needs to squeeze out another .1%-.2% of expenses from his managing firm. If he starts saving later in life, he may need to squeeze 2-3% from expenses, which is probably impossible. The bulk of his retirement will have to come from somewhere else. That's a pity, but what other proposal promises even a fraction as much, most of the time? Most investment managers who must constantly meet payroll with endowment income feel pretty satisfied with 5% total return, employing the 60/40 method. The HSA investor has no payroll to meet, and often needs to do somewhat better to survive.

Just about the only way, one can give it all to him fairly safely, is to use passive investing for a long escrowed time. Lower fees, buy-and-hold. But watch yourself, since managers are often replaced by new managers. We're definitely not saying,"buy and neglect".

In later sections of this book, we take up additional issues of, say, funneling money from Medicare to retirement. If science cures a few diseases; or transferring money from grandparents to grandchildren after research renders medical risk superfluous for retirements; or otherwise using extra funds for new purposes as chance and vigilance make it possible. But all of these windfalls require some sequestered fund to be protected against raids by pirates. Certain segments of the financial community will resist any or all of them. After all, most of the time your gain will be someone else's lost income.

But more fundamentally than that, banks, in particular, are also in the business of taking short-term deposits and making a profit on turning them into long-term assets at higher rates. If you persist in keeping idle money at short-term rates, they will take your money and use it in this way. Curiously, globalization tends to create more short-term loans on components of what was formerly one single long-term loan on an assembled unit. This tends to unbalance the normal ratio of long-term to short-term, in the direction of excessive short-term availability. For the person approaching retirement without any way to pay for it, there is little choice but to take more risk. That is to say, if your goal is to avoid risk, don't dawdle until there is nothing you can do but take a risk. So, start saving young, start investing young, and learn your game. One old sage, maybe it was Ben Franklin, used to say, "The best thing which can happen to you, is to lose some money when you are young." Ben Franklin didn't like to lose money at any age. What he meant was, if you wait too long, you're likely to be stuck.

Originally published: Thursday, March 10, 2016; most-recently modified: Thursday, May 16, 2019