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| Dave Owens |
Imagine you’re
heading out to buy that new car. You
stride confidently into the dealership and tell the salesguy that you want
something HOT. You want something
SLEEK. You want something SEXY. You want something that you can be proud of
for years to come. He grabs a key from his
salesguy key board, and walks you over to a section of brightly painted
cars. As he unlocks the door, turns the
key, and fires it up, he tells you about the features of your future purchase.
Salesguy: You are
going to LOVE this ride! It has power
doors – AND windows! Check out the sound
system…AM/FM/Cassette with (a gleam in
his eye) Push-Button-Stereo. You are
going to love your brand-spankin’-new 1982 IROC-Z!
You: Errr, well…it has
nice power, but what about modern features…like navigation or air bags?
Salesguy: You don’t
really need a navy-what’s-it-bag. This
machine has everything you’re looking for…just listen to that engine roar!
And on he
goes.
WARNING!!!
The rest of this article should only be read if you’re interested – I
mean really interested – in your
financial future!!!
Let’s look
at your 401(k) (or 403(b), thrift savings plan, etc.). Ok, the truth is your plan probably isn’t killing you…but it may be killing your
retirement. Do you remember 2008? The S&P 500 (and the market-based
retirement plans along with it) took a nose-dive! If you were 30-years-old that hurt, but it
wasn’t detrimental. You have time to
recover. What about when that happens
and you are 60? Are you ready for your
new career as a department store greeter?
IRS Code
401(k) was instituted in 1978, and gained a lot of traction in the 1980’s. Lest you think I have a personal grudge
against 401 (and other qualified plans), let’s look at some of the primary advantages:
1. They
take advantage of market gains.
2.
Employer
matching = more free money.
3.
Tax
deferred contributions.
Market Gains
In the
1980’s and early 90’s, market gains were tremendously high. Everybody was a market genius. For every $1.00 you had invested in the
S&P 500 in 1982, by 1996 you had over $10.00! Who doesn’t want that deal, right??? But the new millennium brought a new trend –
losses. And it brought a lot of
them. For every $1.00 you had
invested in the S&P in 2000, by the end of 2002 you were down to $0.62. And had you invested $1.00 at the
beginning of 2008, you were down to $0.63 by year’s end. That’s twice in less than 10 years!
Actually,
you probably did worse than that.
According to the good folks at The Motley Fool, and summarized nicely by
Zero Hedge Fund, less that 1% of money managers were able to beat the S&P
500 over the last ten years.
Have you
heard people say, “I’ve lost over half of my retirement savings…” and wondered
if they were exaggerating? Odds are they
weren’t.
Let me show
you a math trick: Let’s say you have
$100,000 in a retirement account. In
year one, you gain 10% (Congratulations!), and in the next year you lose 10%
(Sorry, my friend). You averaged a 0% return over those
two years, so how much money do you have in your account? If you said “$100,000,” then you are EXACTLY
the person Wall Street wants you to be!
You actually have
$99,000. Here, I’ll show you: Year one…$100,000 * 10% = $10,000. So, then $100,000 + $10,000 = $110,000. Year two…$110,000 * 10% = $11,000. So, then $110,000 - $11,000 = $99,000. It works out the same if you lose 10% then
gain 10%. Open your calculator app and
test me. This principle cannot be overstated: AVERAGE
DOES NOT EQUAL ACTUAL. You averaged
0% over two years – a wash. But you
still lost money. And we haven’t even accounted
for management fees (they get theirs whether you win, lose or draw) OR taxes
owed (remember that you wanted to defer them. That doesn’t mean you don’t pay them. More on that later).
Let me show
you this simple example to drive the point home, and then we’ll move on. The
first column shows your balance at the beginning of the year. The second shows the percentage you gained or
lost that year. The third shows the
actual money gained or lost, and the fourth shows your year-end balance. The last column shows that your average
percentage return was a positive 2%
Beginning
|
Return
|
Gain/Lost
|
New Balance
|
Average Return
|
$100,000
|
+25%
|
+$25,000
|
$125,000
|
|
$125,000
|
-21%
|
-$26,250
|
$98,750
|
|
$98,750
|
+25%
|
+$24,688
|
$123,438
|
|
$123,438
|
-21%
|
-$25,922
|
$97,516
|
|
$97,516
|
+25%
|
+$24,379
|
$121,895
|
|
$121,895
|
-21%
|
-$25,598
|
$96,297
|
+2%
|
“Congratulations! These last few years have been very
turbulent, but your account has managed to maintain an average of 2% growth in
this tough economy!”
If you’re
reading your ‘average since account inception,’ or ’10-year average,’ etc.,
you’re likely misled regarding what your account is actually doing. And if you’re like most people you continue
to fund this account every year, so you’ll never see the balance dropping (or
at least failing to keep up with the average that’s reported). Look again at the table above, and imagine
adding $15,000 to the beginning balance each year. Would you really notice that your ‘core’
money is losing? Don’t feel bad; most
people don’t.
Employer Match
I considered
going into a bunch of statistics about fewer and fewer company matches, but I
decided not to. Heck, I’ve already nearly
bored myself to death writing this
article. If by some small chance you’re
still reading, aside from having my deepest sympathy, I’ll make just a simple
statement: Either your employer matches,
or they don’t. Odds are they don’t. For those few who do get free money from the
boss-man, that contribution may-or-may-not be enough to offset the other negative
attributes inherent in 401(k)s. There
are some mathematical formulas that can help you figure that out.
Tax Deferral
Again,
imagine it’s 1982. If your annual
adjusted gross income is over $85,600, your federal income tax is 50%. That’s right – 50% off the top to Uncle Sam. Check out this link if you don’t believe me –
or if you’re just having trouble falling asleep.
Back then,
it made sense to defer paying taxes.
Taxes were high, and it looked like they were coming down. (In fact federal taxes have been in a steady
decline until just last year.) Today we
have record national debt, including two wars we haven’t paid for, and a major
recession we haven’t completely recovered from.
Which direction do you think taxes are headed?
Let’s agree
- we don’t like taxes. Yes, we must pay
them. And yes, there are some very
necessary programs which are funded by them.
But we still don’t like it. Have
you ever hooked your finger with a fishhook?
I have. Would you take it out
right away (painful as that is) or ‘defer’ removing it until some future
date? How often in your life have you
deferred (postponed) something negative – and it turned out better than if you had just gotten it
over with? Yeah, me either.
Conclusion
Remember
those three advantages to having a 401(k) back in the 80’s?
1.
They
take advantage of market gains, but at
what risk?
2.
Employer
matching = more free money, well maybe
and maybe not. And is it enough to
offset other factors?
3.
Tax
deferred contributions; they defer to
what…a higher tax bracket?
Is there a
solution? YES!! It turns out
that they continued making new cars past 1982!
Some of those cars are really, really cool. Which one is right for you? Well, I don’t know yet. Imagine walking into that dealership, and the
salesguy says something like this:
Salesguy: Hi,
friend. I have the perfect car for you
(as he grabs your arm and walks you to a section of brightly painted
cars). You are going to LOVE this
ride! It has GPS/Navigation standard,
all the safety features…and the power.
Oh, you’re going to love the power.
You: But, this is a
sportscar. I’m looking for something a
little more economical.
Salesguy:
Economical??? Speed! That’s where it’s at. Listen to that engine roar!
You: But, I have 3
kids. How will I ever fit them into
something like this? I don’t think you
really know what I need.
I have five
kids, and my fiancée has two. We might
be in the market for an airport shuttle, or maybe a small school bus very
soon. The point is you need to meet with
somebody who understands what you’re looking for, your needs, and can work with
you on a correct plan – for you. There
are some great options available today that you may never have heard of.
There are
retirement products which offer:
o
great
market-related returns
o
no-loss
provisions (you can’t lose money due to market losses)
o
tax
free growth
o
overall
reduced tax liability
o
liquidity,
use and control of your money
o
flexibility
in funding
o
varying
additional benefits
“Where can I
get such a HOT, SLEEK, SEXY machine?” you might ask. (HEADS
UP: This is the part where I
shamelessly promote my own business.) Look for a group or individual (a-hem) who does NOT charge management
fees. Look for somebody who is
independent, and not ‘married to’ a particular company or product. Look for somebody who is willing to teach
you, instead of being interested only in selling something to you. Look for somebody who is in your corner. We are out there.
Dave Owens
is a vice president and founding member of Ironclad Wealth Strategies. Contact him for free advice or consultation.
dave@ironcladwealth.com
