By BOB CUNNINGHAM
Continuing with the post from last week, in which we are examining some basic financial principles from a “fantasy and reality” perspective:
“Invest in your company’s 401K Plan.” The most common workplace retirement savings vehicle is a 401K Plan, which is a qualified (i.e. government-sponsored) account in which the company holds your money and pays a brokerage to invest it for you into various securities.
FANTASY: Max out your 401K Plan (the government places limits on how much you are allowed to contribute annually) as soon as you can. The government is truly generous in allowing us an account that can grow tax-deferred.
REALITY: Doing so means you’re trusting others to manage your money, in markets that are risky and volatile, and forfeiting access to your money until you’re age 59 1/2 (unless you want to pay a 10% penalty on top of standard taxation) and the account has been in existence at least five years. It’s true that many companies offer a match up to a certain percentage of your income. As a secondary retirement savings instrument, I’m fine with maximizing the company match (example – company matches 25% of the first 5% you have deducted from your paycheck to be put into your 401K). Otherwise, there are better places to put your savings where you have safety and complete control. And once and for all: Tax-deferred doesn’t mean tax-free, and it doesn’t result in more compiled money once you’ve paid income tax at the back-end.
“The most important aspect of investing is Rate of Return.” How much compound interest your money makes as it is invested in stocks, bonds, precious metals, real estate, or any other from among a host of investment choices IS something you’re going to want to track. But there are other factors.
FANTASY: You should be investing your money where you can earn the highest returns. The stock market has risk, but it has gone up steadily over the long-term so if you leave your money in the markets, you’ll most certainly come out ahead.
REALITY: I can’t quite recall where I first read the following, but the adage is oh-so accurate: The most important part of savings and investing isn’t the return on your money. It’s the return of your money. I’ve never fully understood why otherwise sensible people have allowed themselves to become convinced that they should put their hard-earned life savings at significant risk. In 2008-09, I personally knew folks who saw their nest-eggs drop by 40 percent. They are just now fully recouping those losses, and that’s amidst the longest-lasting bull market in any of our lifetimes. Remember, in a previous post we demonstrated how a 5% return every year can out-perform and average of 10 percent over the same period, in the same way that a 50% gain followed by a 50% loss results in a 25% net loss (Don’t believe me? Try it starting with $100 to make the math simple). Slow and steady wins the race. Just ask either the tortoise or the hare. Better yet, ask them both. Wouldn’t steady gains with no market risk – that’s zero risk, ladies and gentlemen – seem to be more intelligent when it comes to something as important as retirement savings? As opposed to hoping your funds return double-digits and avoid big declines along the way? The answer is yes, because it is,
“Buy term and invest the difference.” This expression, of course, is referring to life insurance. There two primary types – term and permanent. Term insurance is solely a death benefit in exchange for a monthly (or annual) premium. Permanent insurance includes products like whole life insurance, and can be set up to function in several capacities in addition to providing a death benefit.
FANTASY: Because term is cheaper, it is advisable to buy term and then take the amount of money you’re saving on premiums versus permanent insurance and invest it in the stock market or other vehicle for long-term returns.
REALITY: It sounds logical enough on its face, but two big problems here. First, the vast majority of folks who intend to follow this strategy won’t “invest” the difference. They will spend it… on stuff that depreciates. And I simply don’t believe in unrealistic advice, even if the logic is sound (which it really isn’t here). Secondly, there’s an obvious reason that permanent insurance tends to be more expensive than term. IT DOES A LOT MORE FOR YOU! Dividend-paying whole life, the product choice for permanent insurance suggested by this blog, offers a host of “living benefits” in addition to the fundamental death benefit. The premiums are higher because the product is superior, on numerous levels. To recommend term strictly because it’s cheaper demonstrates a lack of reasonable research and comparison.
I hope you enjoyed this review and reaped some additional wisdom, or at least some reinforcement, from it. Once again, thank you for taking time from your busy schedule to join us weekly on this site.
DISCLAIMER: This post represents the author’s opinions only. In no way should any part of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific company or investment. Results are never guaranteed. Utilize the information as you see fit, make all money decisions at your own risk.