FOUNDATION POINT 2 - You believe that your 401 K/IRA, etc. is important to your retirement. Unfortunately this is rarely true. Your 401 K/IRA is a very important RAINY DAY FUND.
Let's say you have money invested in a 401K (and that is a VERY good idea).
Your 401 K should eventually represent maybe as much as 20% of your total net worth.
Now, let's say that you had $20,000 you put in, 20 years ago (play along with me even if you were 10 or 50 years old then...)
People have this funny brainwashing problem going on that "compound interest" "over time" will make them rich.
It won't.
Let's say that $20,000 was put into a magical investment that guaranteed 7% per year over 20 years. How much would you have at the end of the 20 years in your company 401 K, assuming they didn't skim, steal your money, that they actually put the money IN the fund. OK?
Well you know about the Rule of 72 better than I do. Take 72 divide it by 7(%) and you end up "doubling your money" in 10.1 years. So you QUADRUPLE your money in 20 years! WOW.
1 dollar turns into 2 and 2 turns into 4. Sounds cool in theory...
Except that isn't real and it can't happen.
Nope, you see there are three things that you don't know about...at minimum that caused that to not happen. (There's one devastating bonus disaster too...but I'll come to that in a minute)
Inflation. Let's say inflation was 3% per year just for argument sake. I know it's not. JUST PRETEND.
Fees of the company running the 401 K. Let's call it 1%. It's often more, but PRETEND it's 1%.
Fees of the mutual funds the company running the 401 K is putting the money in, including the sales commissions paid to the company from the mutual fund companies? 2% and often waaaaaay more. BUT
PRETEND it's only 2%.
...and let's also pretend there are no sales charges for the funds...another stretch but work with me....
and the most painful of all?
These fees are all annual....not one time shots.
GULP.
Now do NOT get me wrong. People DESERVE to get paid to take GOOD CARE of your money.
Companies that are steadfast, loyal and true, DESERVE to be paid to invest your money.
If people take GOOD CARE of your money they deserve to be paid. Agreed? I LOVE FINANCIAL PLANNERS. THEY ARE THE NUMBER ONE READERS OF Coffee with Kevin Hogan. I respect...
the very good ones.
Obviously most financial planners are like most doctors or teachers or dog catchers or motivational speakers.
They are....average.
Now, I could show you the real numbers as to how this completely breaks down but it gets a bit disheartening.
The fact is if you put your 20,000 in and then take out the fees and inflation you end up with nothing at 7% guaranteed return. (Really you end up with A LOT less but all that for later.)
Nothing. Zip. Nada.
Now the next problem is that 7% is high. Way high.
No one can guarantee you 7% per year. (They can but they will go bankrupt like so many pension funds and 401 K "plans" do...Your money will go POOF.)
Real life?
I'm going to speculate that the market, will go up a bit to have the DOW end up at 9000 by the end of the week. Is this going to happen? No. But round numbers work so much better and I like to be an optimist....
So the DOW "mutual fund" ends the week at 9000.
Using the numbers we just ran through, what would the market have had to have been 20 years ago to make 9000 dead even? No gain. Not losing money...not gaining money.
Take the 9000 and divide by 4. (Quadruple remember?)
Right
2250 in October of 1989 makes 9000 on the DOW dead even 20 years later. (Inflation and fees)
Simple so far?
2250 plus inflation, plus mutual fund fees, plus corporate planner fees, plus 20 years = 9000 to stay even steven....
Now I have to go click at my brokerage account to see what the market REALLY was 20 years ago.
OK
It was 2148.65 exactly 20 years ago today when Sergeant Pepper taught the band to play.
SO, TWENTY years ago, you stuck ALL of your retirement money in the DOW, the safest of all the stock investments and you end up 20 years later with the same purchasing power as that day 20 years ago.
Everything you BELIEVED about investing turned out to be wrong.
In fact, it's not just you and me, it's corporate America too. They started promising workers "pensions." A pension is free money that is given to someone in return for doing nothing. The idea is that the company will stash money in investments that will return 10-12% per year.
And I tell you what...if anyone could do THAT you could get wealthy....but it isn't real. And that's why pension plans have lost all their employees/client's money.
For whatever reason, seemingly smart people were caught off guard and shocked that they had been lied to for decades....the market doesn't return 10% year.
Turn the page for FOUNDATION POINT 3: The Big Disaster ...
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