Wednesday, June 26, 2013

Is Your 401(k)illing You? - A Guest Blog by Dave Owens, Vice President, Ironclad Wealth Strategies



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 fiancĂ©e 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