Tail Wags Dog

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If a teaspoon of medicine does you good, are 10 tablespoons necessarily better?

Can’t too much of a good thing be a bad thing?

In pharmacology there’s a term called the “therapeutic index.” This is the range at which at which a medicine does more good than harm. If drug levels are too low the drug is ineffective. And if the levels are too high the therapy can cause toxicity.  The therapeutic index is the sweet spot between too much and too little.

This is a useful metaphor in many arenas.

Take taxes.

In my post entitled Death And Taxes , I made the claim that investors should try to minimize their investment tax burden in order to maximize savings.

The underlying idea was to be thoughtful in your asset allocation and placement.

It’s a good strategy to avoid the unnecessary selling of stocks since this avoids capital gains taxes which can rob investment accounts of appreciated value. (This is one of the many reasons why passive investing trumps active investing.)

It’s also a good idea to be thoughtful as to whether you place certain types of stocks or bonds in taxable versus tax sheltered accounts.

And it’s a great idea to shelter as much of your investments in legal tax protected vehicles as possible.

(The backdoor Roth IRA is one such vehicle for high income earners.)

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But the idea is not to avoid paying taxes, per se. It is to take home as much of your paycheck as possible, (in order to save more of your take-home pay, in order to reach financial independence at an earlier date.)

The desire to avoid paying taxes for the sake of tax avoidance alone is pure silliness.

Take the argument that you should buy a more expensive house because home interest is tax-deductible.

While it’s true that you may pay as little as $.50 on the dollar for home mortgage interest, keep in mind that the interest in itself is completely without value. Actually it has a negative value; compounded interest for the bank, compounded debt for you.

So while it makes more sense to pay interest on your home, than say to pay interest on student loans, or car loans, or credit cards, The best amount of interest to pay, is no interest at all.

I think this can be a “not seeing the forest for the trees” problem.

It’s easy to get obsessed with tax avoidance (trees), because taxes can have a negative impact on your ability to save and thus to reach financial goals (forest).

But the financial goals are the ends. And unnecessary tax avoidance is only one of the means to the end.

When tax avoidance becomes the goal in and of itself, as in purposely having a bigger mortgage to deduct more interest, The tail is truly wagging the dog.

By focusing on the strategy instead of the underlying philosophy, what is truly important (your goal of financial independence) becomes more remote and your energy ends up being expended on counter productive activities.

Which is why having a clear goal is so important.

By having a first principle, one possesses a litmus test by which all future decisions can be measured.

If an action moves you closer to your goal, take it!

If not, probably best to leave it.

Do you have a clear goal that you are working towards?

If not, are you ready to do a little soul-searching? What do you have to lose?

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