Don’t Fall For The MAGIC MATH!
Many financial advisors and brokers use AVERAGE ANNUAL RETURNS to show past performance…..which are absolutely useless and deceptive. It’s one of the oldest tricks in the book to inflate returns without actually lying!
Here’s what we mean:
You start with $10,000, and in year one you earn 100 percent. Your account balance is now $20,000. In year two, you lose 50 percent. Your account balance is now back down to $10,000.
What did you really earn? Nothing! Your account balance is the same as when you started.
Annual average returns say that you earned 25 percent (100 percent – 50 percent = 50 percent divided by two years = 25 percent). So you tell me? What is your true rate of return? 25 percent or 0 percent? The answer, of course, is zero.
Here’s a test to see if you actually understand it. If you open up an account with $1000 and get an Average Annual Return of 20% how much money would you have at the end of 2 years?
IS IT A: $1440? B:$1120? C:$960? or D: $0?
Most logical thinking people would say A: $1440 because the did the math this way – 2 % the first year is $200. Add that to $1000 and now calculate 20% of $1200 and that equals an extra $240. Add those two together and you get a solid $1440.
Problem is…all of these answers are correct when it comes to AVERAGE ANNUAL RETURNS. What if you earned 40% the first year but then lost 20% the second year? 40 – 20 will still average you 20% but you only have $1120 dollars in your account.(Answer B)
What if you hit a homerun and earn 120% the first year! Then lose 100%. Guess what, you averaged 20% but you have no money. (answer D)
The only true number that gives you what you need is average compounded returns. The truth is, if you re-invested dividends of the S&P 500 stocks and did the math properly, the return has been calculated at less than 4% for the last 85 years! REFERENCE: 2011 DALBAR Quantitative Analysis. That would tend to make more sense if you considered that from 2000 to 2010 ( a ten year period) the actual S&P index was negative!
Taking Social Security at age 62!
We don’t sell Social Security nor do they send us a commission if you wait to take your benefits. The impact of when you take your Social Security is hard to calculate unless you know when you are going to die for 100% certainty. The barber shop answer for when you should take your benefits has always been to take them as soon as possible. However, most people don’t realize that every year you wait, the amount you receive will increase by 8%. Where else can you get 8% return?
Here’s another tidbit: The larger check will be the one you can claim if your spouse dies. So typically the bread winner should delay as long as possible.
Under-estimating your longevity or health-care costs.
You’ve built up a retirement nest egg, but that doesn’t mean you should embark on a spending spree. You need to remember that one member of each couple reaching the age of 65 stands a 50-50 chance of living past age 90, and longevity is increasing all the time. There are now contractual guarantees available that will give you and your spouse a lifetime income AND hedge against inflation with the possibility of increases in income with market increase, but no decrease on market declines.
With advances in medicine longevity is increasing, not only is there a 50-50 chance one spouse will live past 90, the same odds exist that one will spend over 2yrs in a long term care facility. The costs of a long term care stay can crack and scramble a nest egg! Consider purchasing long term care insurance at a young, healthy age if possible.
Take a friend or family members advice about your Medicare choices.
We can’t say enough about this mistake. This can be an irreversible mistake.
Medicare choices are complicated. People tend to take the path of least resistance in their selections and just ask someone who is already on Medicare “Are YOU satisfied with what YOU have?” Then just mimic their choices.
Just remember this: When you are first enrolling in Medicare, you have all of the choices available to you. After the first 6 months passes, you are subject to a different set of rules. IF you choose a Medicare Advantage plan, you must go to the doctors they tell you to. If you find out you don’t like the doctors they require, then your only way out is to go with Original Medicare plus a Medicare Supplement. NOT SO FAST. Once you pass open enrollment (the first 6 months period) you will have to answer medical questions that you did not have to answer during the first 6 months open enrollment period. You can be denied.
Then there’s your prescription drug plan (Part D). Are you on the same medicines as the person who recommended the drug plan? If not, you would be wise to learn how to use the governments website to shop for the best plan and enroll. For more details, see www.teachmeaboutmedicare.com
NOT MAKING SURE YOUR IRA IS INHERITABLE.
IRA rules allow for spousal continuation. However, all IRAs are not inheritable. Not all IRAs escape probate either. If you die and don’t have a spouse, your non-spousal beneficiary could be forced to receive all of the IRA funds and the tax bill associated with it. An inheritable IRA allows for the non-spousal beneficiary to receive payments based on IRS RMD tables and can actually be paid out through 2 generations or so depending on the age of the beneficiary at the owners death. This mistake is similar to mistake #1 but not quite as common.
Withdrawing too much money.
After a lifetime of saving, you may think at age 55 or 60 that it’s time to start siphoning some of that hard-earned cash out of your retirement accounts and pay off some bills before you retire. The idea sounds fiscally responsible but could cost you dearly in the long run.
There are conflicting schools of thought when it comes to taking income from your retirement savings. Some experts recommend that retirees wait as long as possible to begin taking distributions from qualified accounts to ensure their money will last throughout retirement. The experts who say that are usually getting paid on your account balance and it will reduce their income if you do….so that advice has conflict of interest written all over it. However, if you had to structure an income based on your account balance and your account has risk, then this is an exercise in futility. There is no way to budget for an income based on a balance that could go down! If you budget for 5% (an industry recommended standard) and you have $300,000.00, then your income would start out at $15,000 annually. If you don’t get any market gains during that year, your balance the next year will be $285,000. Now you must reduce your income to meet the 5% formula. Worse yet, if the market drops 20%, you may have to go back to work to meet your income needs, OR take a larger percentage of your remaining funds….either way, you are creating a pending financial train wreck.
We are not among those experts who give this advice. We encourage you to get a contractual guarantee for income that is dependable and inflation proof. In almost all cases, we encourage clients to start their retirement income as soon as both husband and wife turn 60. If they don’t need the money and are still working, just put in savings for a rainy day…because the income stream will never stop until you both have deceased.
CASHING IN YOUR RETIREMENT BEFORE AGE 60.
Times are tough, but this should be the absolute last resort to a financial bailout. Chances are if you have to do this, it’s only going to delay the inevitable. By the time penalties and taxes are paid, you are only going to be getting 50 cents on the dollar. Don’t use your retirement funds to make an investment purchase either.
One fact that most people don’t realize until it is too late is that 401ks, IRA’s and Pensions are PROTECTED FROM BANKRUPTCY. You don’t even have to list them as an asset. So why give the government your money in fees and taxes? If you are in a financial bind, resist the urge to dip into retirement.