Author Topic: Extremely risky market timing strategy to use to gamble w/ your 401k  (Read 4922 times)

a1pharm

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I just had an idea that is a very risky way to make money timing the market.  Just to be clear, I won't do this, and would advise no one to ever do this.  I'm just bringing it up to you smart folks to find out if the reasoning is true:

0. Be contributing the max to your 401k each year, continue to do this
1. Right before the market tanks, take the max loan you can from your 401k.
2. Pay the origination fee ($75 typically)
3. Get the money, and put it in a muni bond ETF in your taxable account.
4. You have to pay interest on the loan, but that interest goes right into your 401k.
5. This interest is one way to put in more than the 18k yearly max into your 401k (4% on 50k loan = 2k per year "extra" to add to the 401k)
6. Use the gains/sales from your muni bonds to pay minimum payments on your 401k loan.
7. When the market is at the bottom, payoff the loan in full

Benefits:
1. You make post-tax money (a small amount) on your bonds
2. You get to add more than the legal max to your 401k in a year (the interest rate of the loan * balance = the "extra")
3. The opportunity cost of the loan (what you would have made on the money if it would have stayed in the 401k) is not negative (the market was going to go down, so it would have eroded in value).

Disadvantages:
1. It's stupid
2. It's risky
3. No one can time the market

Assuming one can time the market with 100% accuracy, what are the problems with this strategy?

This is just a thought exercise, not advice for someone, not something I want to do.
« Last Edit: October 09, 2016, 01:33:32 PM by a1pharm »

Metric Mouse

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #1 on: October 09, 2016, 08:00:38 PM »
.....
Assuming one can time the market with 100% accuracy, what are the problems with this strategy?

This is just a thought exercise, not advice for someone, not something I want to do.

Um... cuz it's really hard? If I could time the market with 100% accuracy, I would leverage a lot more than just what I would be able to loan from a 401K.

Heckler

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #2 on: October 09, 2016, 08:05:09 PM »
I think Ill just sell my house, take the proceeds to Vegas and put it all on the winning number on the table.  Maybe get a loan shark to front a bit sonce I know Ill win.

Tjat

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #3 on: October 10, 2016, 06:58:02 AM »

Assuming one can time the market with 100% accuracy, what are the problems with this strategy?


Because it's a waste of time to think about. In the world of omnipotent investor fantasies, spending time dreaming about making a measly return from a 401K is silly. If you can time the market with 100% certainty, you'd exhaust your credit limits, sell your house, etc. and buy as many 3x leveraged naked options as you could possibly afford. Pretty quickly you'd have more money than the rest of the world GDP. For as little time as one has to daydream, you gotta dream big.

Roland of Gilead

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #4 on: October 10, 2016, 07:20:06 AM »

1. Right before the market tanks, take the max loan you can from your 401k.


Great strategy except for #1.   If you can do #1, why screw around with a 401K?

Sell your house, car, dog and right before the market tanks, buy as many SPY puts as you can afford.

Step #2:  Retire on an island you just bought.

WerKater

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #5 on: October 10, 2016, 10:15:37 AM »
Assuming one can time the market with 100% accuracy, what are the problems with this strategy?
Assuming one can time the market with 100% accuracy, one can make infinite money anyway, so no need to bother with any strategy.

a1pharm

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #6 on: October 10, 2016, 05:25:24 PM »
I should have been more clear, the reason to take the loan out is not to buy more stock, but to do 2 things:

1. "Shield" some of your nest egg from loss (you could also do this by just rebalancing)
2. Get the 4% APR added to your 401K while minimizing your opportunity cost "loss"

Mighty-Dollar

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #7 on: October 10, 2016, 11:26:21 PM »
Quote
Right before the market tanks
How do you know in advance that the market is going to tank????

bryan

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #8 on: October 11, 2016, 02:10:57 AM »
First off, very boring that folks are shouting about market timing. (Let's assume portfolio stays balanced, always). I think it's interesting purely from perspective of yet another loophole to stuff in after-tax contributions into your 401k, which can then be converted to a Roth IRA (Is this last bit true, that it is identical to after-tax contributions, the 401k provider, e.g. Vanguard, show these interest payments separately or can be tracked on your own separately?)

Getting fired seems to result in the loan being "called." Pay it back within X days.

Maybe too much risk, complexity to worry about for the ~$2200 (4.5% - fee) extra into a Roth IRA?

How would the strategy change between Roth or Traditional 401k? (I assume be very weary w/ Roth; be weary with Trad.).

It's never registered with me that the interest payments of 401k loans are just payments to yourself..

Back to market timing.. I guess this strategy is best if you expect assets to stay stable or fall compared to the APR (kind of the opposite of not paying of low interest rate home loan and instead investing in stocks). If asset prices rise while you are paying back on the loan (good average assumption based on long-term historical trends), you have basically lost some tax efficiency (which will compound), trading tax-deferred/free dollars for after-tax dollars.
« Last Edit: October 11, 2016, 02:51:12 AM by bryan »

a1pharm

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #9 on: October 11, 2016, 07:37:23 AM »
First off, very boring that folks are shouting about market timing. (Let's assume portfolio stays balanced, always). I think it's interesting purely from perspective of yet another loophole to stuff in after-tax contributions into your 401k, which can then be converted to a Roth IRA (Is this last bit true, that it is identical to after-tax contributions, the 401k provider, e.g. Vanguard, show these interest payments separately or can be tracked on your own separately?)

Getting fired seems to result in the loan being "called." Pay it back within X days.

Maybe too much risk, complexity to worry about for the ~$2200 (4.5% - fee) extra into a Roth IRA?

How would the strategy change between Roth or Traditional 401k? (I assume be very weary w/ Roth; be weary with Trad.).

It's never registered with me that the interest payments of 401k loans are just payments to yourself..

Back to market timing.. I guess this strategy is best if you expect assets to stay stable or fall compared to the APR (kind of the opposite of not paying of low interest rate home loan and instead investing in stocks). If asset prices rise while you are paying back on the loan (good average assumption based on long-term historical trends), you have basically lost some tax efficiency (which will compound), trading tax-deferred/free dollars for after-tax dollars.

Thanks for seeing my point Bryan: another loophole to shove more money than the legal max into your tax advantaged account.

I don't think this would ever be a worthwhile thing to do if all of one's tax advantaged accounts were not already maxed out.  However, once someone gets to that point, and they have enough going into their taxable account, this is just one more weird option to get more money into the 401k.

As for market timing, the only relevant part is that you take the loan sometime before a market correction (downturn) so your opportunity cost isn't stupid.

I am just wondering if my reasoning on the loophole is valid/legal.  I was not intending to debate the merits of market timing, which was mentioned in my first post, but was ignored by a few complainypants...

Cycling Stache

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #10 on: October 11, 2016, 10:00:19 AM »
I am just wondering if my reasoning on the loophole is valid/legal.  I was not intending to debate the merits of market timing, which was mentioned in my first post, but was ignored by a few complainypants...

The problem is that the key assumption--that you can market time--is ridiculous.  It's like saying, "If I had a time machine, would it be a good idea to . . . "  It's hard to answer that question without challenging the assumption.

This entire thread made me think of trying to optimize your walk to work to increase your odds of picking up spare change off the ground.  It's that pointless.  The idea is that if you're good enough with market timing to make your assumption valid, you don't try to figure out how to make a couple grand off it.  You make a couple million, billion, etc.

That's why you're getting the responses you're getting.  It's not that people are complaining.  It's just based on a flawed assumption that is fatal to the question if you are imagining real answers.

If you're not, then I say, yes, you should do it, and use the money you make to buy a unicorn.

MustacheAndaHalf

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #11 on: October 11, 2016, 10:19:18 AM »
Let's say everyone learns at the same moment that interest rates are about to change significantly, and will drop the stock market by 20%.  Meaning Vanguard Total Stock Market would drop from $111 to $89 because of interest rates.  If a stock market downturn is certain, everyone tries to sell first.  Why take a -20% drop when you can sell now at a 0% drop?  Next seller isn't quite as good, but is perfectly willing to avoid an -18% drop, and so on.  The market panics until stock prices reflect the certainty of a stock market correction.

So to profit off a market drop, you really need to be not just the only one aware of it, but also the only one certain it will happen.  If experts think it's a 33% chance, you would see panic selling until 1/3rd of the expected correction is reflected in the market.  Any chance of a correction should be priced into the markets by buyers and sellers of stocks.

a1pharm

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #12 on: October 11, 2016, 07:16:37 PM »
I am just wondering if my reasoning on the loophole is valid/legal.  I was not intending to debate the merits of market timing, which was mentioned in my first post, but was ignored by a few complainypants...

The problem is that the key assumption--that you can market time--is ridiculous.  It's like saying, "If I had a time machine, would it be a good idea to . . . "  It's hard to answer that question without challenging the assumption.

This entire thread made me think of trying to optimize your walk to work to increase your odds of picking up spare change off the ground.  It's that pointless.  The idea is that if you're good enough with market timing to make your assumption valid, you don't try to figure out how to make a couple grand off it.  You make a couple million, billion, etc.

That's why you're getting the responses you're getting.  It's not that people are complaining.  It's just based on a flawed assumption that is fatal to the question if you are imagining real answers.

If you're not, then I say, yes, you should do it, and use the money you make to buy a unicorn.

Ok, so now that we've beat the dead horse (market timing = impossible, just like I said in the first post), let's talk about the potential loophole: getting the APR of the 401k loan back into the 401k.

I guess if I had to start the thread over, I would have just said "I want to use the loan to rebalance my portfolio to include muni bonds in my taxable account, which I'll fund w/ a loan from my 401k.  Assuming my muni bonds cover the APR of the loan (I know - muni bonds won't do that right now, but don't focus on that too much, focus on the concept), is this a valid way to increase my 401k contribution above the 18k/yr limit?

Please try to keep the complainypants comments at bay for a few minutes and focus on this potential newly discovered loophole, and come up with a way to take advantage of it.  The market timing thing was to address some folks' concerns about opportunity cost - but I guess most complainers wouldn't have even realized the opportunity cost issue to begin with...

Let's try to keep the discussions more like MMM and less like Reddit.

Jammu

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #13 on: October 11, 2016, 10:32:32 PM »
It's not a loophole. The interest goes into your 401k less some kind of management percentage. That's just how they work. Like if you bought a bond in your 401k the coupon would be added, and not counted against your contribution.

Or have I just plain misunderstood the question?

frugalnacho

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #14 on: October 12, 2016, 10:23:58 AM »
Benefits:
1. You make post-tax money (a small amount) on your bonds
2. You get to add more than the legal max to your 401k in a year (the interest rate of the loan * balance = the "extra")
3. The opportunity cost of the loan (what you would have made on the money if it would have stayed in the 401k) is not negative (the market was going to go down, so it would have eroded in value).

I don't think this is true.  The "extra" interest you pay for borrowing on your 401k is paid back with after tax money, and yet you are still taxed when you eventually withdraw it.  The interest paid on a 401k loan is double taxed (but not the principle).  You would be better off not taking a 401k loan, and instead instead of putting "extra" (post tax) money into your 401k (as interest on the loan) just putting that money into a taxable account since you already claimed that money on this years tax return.

Goldielocks

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #15 on: October 12, 2016, 10:47:41 AM »
Challenge -- very low payback (the difference of the interest) versus the risk (timing / forced loan if you lose your job, etc)


You need to compare this to just moving your 401k investments into a muni bond, WITHIN your 401k...(to prevent the decline) borrowing to invest outside of your 401k loan strategy.

Your upside is just the difference in interest rates of borrowing to invest the extra monies outside of your 401k into muni fund.   ...   I don't see the need/point to slightly increase 401k contributions.   Won't your 401k be large enough with regular maxing it out that this makes an insignificant difference? 

Just how much do you calculate you can increase 401k contributions by?

« Last Edit: October 12, 2016, 10:51:20 AM by goldielocks »

bryan

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #16 on: October 12, 2016, 11:54:20 AM »
Benefits:
1. You make post-tax money (a small amount) on your bonds
2. You get to add more than the legal max to your 401k in a year (the interest rate of the loan * balance = the "extra")
3. The opportunity cost of the loan (what you would have made on the money if it would have stayed in the 401k) is not negative (the market was going to go down, so it would have eroded in value).

I don't think this is true.  The "extra" interest you pay for borrowing on your 401k is paid back with after tax money, and yet you are still taxed when you eventually withdraw it.  The interest paid on a 401k loan is double taxed (but not the principle).  You would be better off not taking a 401k loan, and instead instead of putting "extra" (post tax) money into your 401k (as interest on the loan) just putting that money into a taxable account since you already claimed that money on this years tax return.

You are missing the part where you can roll over after-tax contributions straight to a Roth IRA. So you pay income taxes on the interest payments (i.e. it is after tax-contribution) and then pay taxes on any gains of those after-tax contributions when you rollover to a Roth IRA.

This is my understanding, that it is treated like after-tax contributions and thus is like a mini-MEGA Backdoor Roth.

I assume this is not a loophole to get over the $53k limit (IRS sees all contributions, even 401k loan interest, and uses that amount to assess penalty). So if you can do MEGA Backdoor, it's preferred (unless you really can time the market, of course).

Challenge -- very low payback (the difference of the interest) versus the risk (timing / forced loan if you lose your job, etc)


You need to compare this to just moving your 401k investments into a muni bond, WITHIN your 401k...(to prevent the decline) borrowing to invest outside of your 401k loan strategy.

Your upside is just the difference in interest rates of borrowing to invest the extra monies outside of your 401k into muni fund.   ...   I don't see the need/point to slightly increase 401k contributions.   Won't your 401k be large enough with regular maxing it out that this makes an insignificant difference? 

Just how much do you calculate you can increase 401k contributions by?

I think asset allocation should remain constant during the scheme OP proposed.

401k or IRA sizes are subjective to a person's situation. Sometimes it won't be "large enough."

$2200/yr sounds close to the max you can get per year but it will depend on how your 401k loan program is set up (each program has it's own interest rate, fees, and repayment options; all plans have an absolute max of $50k loan or half your salary, though). I wonder if you could arrange the scheme so that you optimize for max interest payments throughout the year (probably not so much considering there is a fee for taking a 401k loan, again depending on your 401k provider).
« Last Edit: October 12, 2016, 11:58:53 AM by bryan »

frugalnacho

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #17 on: October 12, 2016, 12:26:19 PM »
Benefits:
1. You make post-tax money (a small amount) on your bonds
2. You get to add more than the legal max to your 401k in a year (the interest rate of the loan * balance = the "extra")
3. The opportunity cost of the loan (what you would have made on the money if it would have stayed in the 401k) is not negative (the market was going to go down, so it would have eroded in value).

I don't think this is true.  The "extra" interest you pay for borrowing on your 401k is paid back with after tax money, and yet you are still taxed when you eventually withdraw it.  The interest paid on a 401k loan is double taxed (but not the principle).  You would be better off not taking a 401k loan, and instead instead of putting "extra" (post tax) money into your 401k (as interest on the loan) just putting that money into a taxable account since you already claimed that money on this years tax return.

You are missing the part where you can roll over after-tax contributions straight to a Roth IRA. So you pay income taxes on the interest payments (i.e. it is after tax-contribution) and then pay taxes on any gains of those after-tax contributions when you rollover to a Roth IRA.

This is my understanding, that it is treated like after-tax contributions and thus is like a mini-MEGA Backdoor Roth.

I assume this is not a loophole to get over the $53k limit (IRS sees all contributions, even 401k loan interest, and uses that amount to assess penalty). So if you can do MEGA Backdoor, it's preferred (unless you really can time the market, of course).


I don't think the interest on the loan is counted as an "after tax contribution", despite the fact that you have to pay taxes on it.  It is lumped in with the rest of your pretax contributions.

bryan

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #18 on: October 12, 2016, 02:17:39 PM »

You are missing the part where you can roll over after-tax contributions straight to a Roth IRA. So you pay income taxes on the interest payments (i.e. it is after tax-contribution) and then pay taxes on any gains of those after-tax contributions when you rollover to a Roth IRA.

This is my understanding, that it is treated like after-tax contributions and thus is like a mini-MEGA Backdoor Roth.


I don't think the interest on the loan is counted as an "after tax contribution", despite the fact that you have to pay taxes on it.  It is lumped in with the rest of your pretax contributions.

Damn, It seems you are correct. The first few google search results I read I came to the after-tax contribution treatment conclusion. Just goes to show how difficult it is to understand all the rules. Here's a TurboTax Q&A that says the loan interest is just treated as gains within your Traditional 401k (and thus is subject to Traditional 401k taxation upon distribution): https://ttlc.intuit.com/questions/2926054-401k-loan-interest-double-taxed and a Vanguard confirmation (see paragraph "Second"): http://vanguardblog.com/2009/07/24/401k-loans-are-you-really-taxed-twice/

So OP's scheme has suffered a significant blow in general usefulness. It could still make sense if you "can time the market" or really need a loan..
« Last Edit: October 12, 2016, 02:21:41 PM by bryan »

Goldielocks

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #19 on: October 12, 2016, 03:31:58 PM »
Even if it did work out, 401k is simply a tax reduction because of the different tax brackets of high income (today) versus low income (retirement).

If as the other indicated, $2200/yr is the max addition one could contribute (if it was allowed as such)...

And your tax bracket now is 35%, and in future it is 15%...(or 45% and 25%)  and this worked for TEN years.

You would only gain a net of $2200/yr x 20% x 10 high income / high loan potential years, plus the compounding interest of that portion until you withdraw it..   IDK pretty complicated over 10 year for a modest $10k or so value back to you...?

Cycling Stache

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #20 on: October 13, 2016, 07:28:18 AM »
I'm not sure why I'm bothering to respond again, but to the extent that it was a serious, non-market timing question, it does not work.

The title to this post was "Extremely risky market timing strategy to use to gamble w/ your 401," which seemed to focus on taking a large loan out of your 401(k) right before a market crash to then pump back into the market after the crash.  That was all dependent on market timing, which is why the responses dealt with market timing.

As to the non-market timing issues, it doesn't work either.

First, you're taking the money as a loan from your 401(k), which means the money that you're taking out of the market to invest back in the market is just a wash.  No additional money goes to the market from the loan.

Second, the money you pay back into your 401(k) as interest is post-tax money, but goes into the 401(k) account with your other pre-tax contributions.  Thus, you're gaining no tax advantage from the additional dollars you're able to pay into the 401(k) as interest, and indeed, may end up paying greater taxes if the ordinary income tax rate at the time you pull the money out of the 401(k) is greater than the long-term capital gains rate you would have paid if you just put the after-tax dollars in a non-retirement investment account.

Third, you're not putting any additional money into the market through the interest payments because you could otherwise have just put those payments into a non-retirement market account.

I took out a loan from my 401(k) and shared the initial excitement in recognizing that the benefit of the loan is that you're paying all the interest back to yourself.  But beyond that, there is no tax benefit or market benefit.  Every dollar you took out as loan was already in the market, and every after-tax dollar you pay back as interest could have otherwise been invested in a non-retirement market account, so no gain there either.

Thus, there is no advantage to this approach other than the "market-timing" approach, which actually isn't a benefit either.  Because you're taking the loan from your own market holdings, you could achieve the same goal by moving your money to a cash holding within your 401(k) until the market drop, then buy back into the market within the 401(k) "after the drop."  The same is true for the "interest" you would have paid, because you just put those after-tax dollars in a non-retirement market account "after the drop."  Of course, as stated above, I would not do this because market timing.

So, no loophole discovered.  The benefit of borrowing against your 401(k) is that the "interest" you pay is all paid back to you, rather than a bank.  The downside is that the money you borrow is not in the market so long as it's borrowed and being used for something other than market purposes.
« Last Edit: October 13, 2016, 07:30:51 AM by Cycling Stache »

a1pharm

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Re: Extremely risky market timing strategy to use to gamble w/ your 401k
« Reply #21 on: October 14, 2016, 04:43:27 PM »
Benefits:
1. You make post-tax money (a small amount) on your bonds
2. You get to add more than the legal max to your 401k in a year (the interest rate of the loan * balance = the "extra")
3. The opportunity cost of the loan (what you would have made on the money if it would have stayed in the 401k) is not negative (the market was going to go down, so it would have eroded in value).

I don't think this is true.  The "extra" interest you pay for borrowing on your 401k is paid back with after tax money, and yet you are still taxed when you eventually withdraw it.  The interest paid on a 401k loan is double taxed (but not the principle).  You would be better off not taking a 401k loan, and instead instead of putting "extra" (post tax) money into your 401k (as interest on the loan) just putting that money into a taxable account since you already claimed that money on this years tax return.

Frugalnacho, you're my hero!  I didn't consider that the after-tax money was going to be locked up and taxed again upon withdrawal.  This makes the benefit EXTREMELY small in only a handful of cases, and actually a detriment in most other cases.

The only way this could still be beneficial is perhaps if all of the following are true:

1.  All available tax sheltered/advantaged accounts are maxed.
2.  The mutual fund choices in the 401k have extremely low ER's (mine has Vanguard institutional offerings with a 0.02% ER - better than I can get anywhere else)
3.  You will pay no taxes on "income" during retirement (there are ways to do this which are legal, but you have to keep your spending very low).

In summary, Frugalnacho's analysis is the first correct response: the "interest" is double taxed in most cases, which makes this strategy non-viable for almost everyone.

Thanks for the discussion, all!