Are you Saving or Investing for your passive income years (retirement)? Safe or Risk?

Beginning back in the late 70’s and early 80’s we began to make a transition in this country as it relates to saving for our passive income years (retirement).

Up  until  that  time,  people  “saved”  for  retirement.  They literally  put  money  in  savings  accounts  to  be  used  in  the future  when  they  retired.  Beginning  with  the individual retirement  account  or  IRA’s in  the  70’s and  later  in  the early  80’s  with  401(k)s,  future  retirees  continued  to  be encouraged  to save  for  retirement  only this  time  it  was suggested  they  invest  in  the  stock  market  through mutual  funds  purchased  with  their  401(k)  money.
In  a  very  short  period  of  time  we  went  from  saving  for retirement  to  investing  for  retirement.  Unfortunately  we were  told  that  the  process  was  still  safe.
Even though there  might  be  some  risk  involved  it  would  be  very modest  and  even  if  the  market  did  drop,  it  would  always come  back.
Because  so  many  people  in  this  country  are  relying  on their  401(k)  to  provide  the  majority  of  their  retirement income it is  extremely  important  that  we understand how  stock  market  returns  are  applied  to  our  retirement accounts.
In  an  exaggerated example  of  how  returns  might  be applied  to  a  lump  sum  in  a  retirement  account,  let’s  look at  an  account  with  $100,000.  Let’s  assume  for  a moment that  there  is  no  possible  chance  for  loss  of  principal  and the  mutual  fund  manager  is  guaranteeing  a  25%  average rate  of  return.
If  this  were  truly  available  it  would  be  a  great  investment for  our  retirement.  So  let’s  apply  some  stock  market returns  and  see  what  happens.
Let’s  pretend  for  a  moment  that  in  the  first  year  our account  experiences  a  1999  type  of  growth.  During  that year  there  were  a  number  of  mutual  funds  that actually returned  over  100%!  You  started  with  $100,000  and  you now  have  $200,000  in  your  account.

You  would  certainly  be  very  excited  and  very  happy  with the  results.  Let’s  go  to  the  next  year.  Unfortunately  in  the second  year  your  account  experiences  more of  a  2008 type  of  year  and  incurs  a  50%  loss.  Now  you’re  not  as  happy as  you  were before.  Two  years  earlier  you  started  with $100,000  then  it  rose  to $200,000  in  value  and  now  it’s back  to  $100,000.

But  you  have  a  guarantee  from  your mutual  fund  manager  of  a  25%  average  rate  of  return,  so with  that  guarantee  in  hand  you  approach  him to  receive what  you  expect  to  be  a  check  for  over  $150,000.

Unfortunately  though  you  did  not  read  the  fine  print  in your  agreement  which  stated  that  you  were  guaranteed a  25%  average  rate  of  return, not  effective  yield.
By  applying  the  math,  100%  positive  return  minus  a  50% negative  return  equals  a  50%  positive  return  divided  by two  years  for  a  25%  average  yearly  rate  of  return!
The  vast  majority  of  mutual  fund  returns  are  recorded  as average  returns  not  effective  yield’s.  What  that  means  is that  average  rates  of  return  mean  absolutely  nothing. The  most  important  number  for  you  to  consider  is  the effective  yield  on  your  money.

That  is  an  example  of  how  market  returns  are  applied  to lump  sums.  

Now  let’s  look  at  how  market  returns  are applied  to  annual  contributions.

During  the  20  year  period beginning  in  1992  and continuing  through  the  end  of 2011, the  S&P  500  with dividends  averaged  9.49%  interest!
There  were  16  positive years  and  only  four  negative  or  down  years.  It  was  a great  time  to  be  invested  in  the  stock  market.
Now  if  you  were  meeting  with  a  traditional  financial planner  and  you  were  trying  to  calculate  what  you  might have  in  the  future  if  you  were  to  give  him  $5000  a  year  to be  placed  in  your  retirement  account  and  you  use  this average  interest  rate  of  9.49%  to  predict  the  future  value of  your  account  20  years  from  now ,  it would  result  in  a figure of  $270,306.  Quite  a  nice  little  retirement  sum.
But  we  know  average  return  isn’t  the  same  as  actual return  or  effective  yield.  So  what  would  happen  if  we took  the  exact  rates  of  return  from  that  20  year period of time and  inserted  them into  your  retirement  calculation.
Due  to the  ups  and  downs  in  the  market  for  what  is commonly  called  market  volatility,  your  effective  yield  or actual  return  would  only  be  5.54%,  significantly  lower than  what  you  are  anticipating.  The  resulting  balance  20 years  later  is  not  $270,000  but  only  $175,165.  That amounts  to  35%  less  money  than  your  original calculation!
In  addition  to  market  volatility,  there  is  additional  item  to be  considered  when  determining  the  actual  rate  of return  you  might  receive  on  your  retirement  account.
The  vast  majority  of  mutual  funds  charge  a  management fee.  Those  fees  can  vary  widely  but  if  the  management fees  applied  to  your  account  were  1.5%  (by  the  way,  fees applied  to  mutual  funds  inside  401(k)s  are  typically higher),  instead  of  ending  up  with $175,000  in  your retirement  account  you  would  only  have  $144,361!  That is  a  little  more  than  half  of  what  your  original  projection was!
Unfortunately,  if  you  been  waiting  as  traditional  financial planning  has  suggested  you  should,  for  the  market  to  come back ,  you  may  have  just  run  out  of  time  and  ended  up with  far  less  than  you  have  been  planning  to  retire!

This  is  exactly  what  has  happened  to  those  individuals who  were 45,  50,  55  year-olds in  1999.  They thought their  retirement  plans  were  rock solid  and  they were set for  a  great  retirement.

Unfortunately,  not  only  did  they get  hit  with  the  2000  through  2002  market  downturn  but they  got  hit  again  in  the  2008  recession.  Now  those  same people  are 58,  63 and 68 year-olds  who  do  not  have enough  time  to  recover  from the  market  volatility  that created  those  market  losses.
Want to know a better way to SAVE for your passive income years? Call me today, Jennifer Hansen, on 845 649 7487 so we can set up a private webinar appointment time.

July 19, 2014 · Jennifer · No Comments
Tags: , , , , , , , , ,  · Posted in: RETIREMENT, SAVING vs INVESTING, Uncategorized

Leave a Reply