So much attention is paid to the growth (or decline) of the stock market that I fear we can become hypnotized by it and fall prey to sloppy fundamentals from time to time.
How do I know this? Because many of the people we work with admit to receiving each investment statement and simply doing the ol’ “Is it up or is it down and by how much?” analysis. The performance of the portfolio is the only metric that receives any attention. For a moment, I want to ask you to consider a few different ways of looking at your financial world that may increase the total value of your hard-earned assets.
1. Reduced spending increases “wealth”:
Let’s say the investments in your nest egg average 5% return between retirement and your demise, just to keep the math simple. For every $1,000 of annual income you need during retirement, you need $20,000 of accumulated savings ($1,000 / .05). Thus, if you need $40,000 of income per year from your investments (not counting Social Security, pensions, etc.) then you will need $800,000 of savings. Using this math, if you’re able to live on $10,000 less per year, that’s the equivalent of adding $200,000 to your nest egg. Do you see how this works? And this doesn’t factor in the tax reduction of withdrawing less taxable income each year.
2. One more year of work creates a huge pay raise:
What if you chose to work just one more year before retiring from paid work? Working an additional year can significantly increase your retirement income in several ways. Every year that you can postpone withdrawing money from your nest egg, the more that money can grow. Let’s say you are 62 and earning $80,000 a year. You’ve saved half a million dollars, and it is earning 5 percent on average. If you wait one more year before retiring, you earn an additional $80,000 of income from your job and you save a year’s retirement expenses of, say, $50,000. That’s money that won’t have to come out of your nest egg now, and it is gaining interest of $2,500 ($50,000 x 5%). When you add it up, it means you actually are making $132,500 by choosing to work one more year. And that doesn’t even include the 7-8 percent boost you get in your Social Security benefits by waiting an additional year. If you are questioning whether you are going to have enough to retire, one more year will make a profound difference in your overall retirement income. Knowing that, you might have a whole new outlook as you head off to work in that last year.
3. Cut Uncle Sam’s Allowance to increase yours:
Here’s another idea. Many retirees have money in tax qualified accounts (IRA’s, 401K’s) that will trigger income tax when withdrawn. They may also have some already taxed money as well (Roth IRA or non-IRA mutual fund account). For simplicity’s sake, let’s assume a 20% tax rate. That means the IRS “owns” 20% of your IRA and 401K accounts if you intend to use the money for retirement income. Rather than use only 401K and IRA money to create income, what if you used a combination of taxable and non-taxable accounts to maximize the 15% tax bracket, rather than push income into the 25% bracket? The effect is to increase the value of your nest egg by the amount of the tax savings. In this case, it’s a 25% reduction in total tax owed ((1-.15)/.20). That’s like growing your money without taking on more risk.
4. Discover the hidden costs of investing:
Did you know that owning mutual funds and variable annuities may be much costlier than you thought? We regularly see mutual fund portfolios that have over 2% annual expenses and variable annuities that carry 3-4% annual fees! Mutual funds are not required to disclose the entirely of the extent to which fees act against fund real returns, and variable annuities often come packaged with costly riders that add layers of expense above the already pricey mutual fund-like subaccounts. The consequence of these fees each year is lower returns for the same amount of risk in an investment portfolio. If you were able to even reduce the fees from 3.00% to 2.00%, you’d see a 33% reduction of internal fees. A reduction of fees means you keep more of the returns, allowing you to take less risk for the same results or net higher potential returns with a similar risk profile.
There’s no doubt that receiving great investment returns is a very valuable endeavor; however, please don’t overlook opportunities to enhance the total value of your assets by using a holistic approach to your planning. Sure, the headlines aren’t as sexy, but the benefits can be just as significant.