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IDEAS THAT ENDURE

Ideas matter. The value of every statistic, every calculation, is determined by the ideas and philosophies to which the numbers are applied.

In the past several years, several trade publications have republished a short commentary on the essential elements of life insurance. Originally titled “Just a Life Insurance Policy,” this is a brief yet powerful statement of the timeless ideals that make life insurance a financially relevant product.

The article, probably written at least 50 years ago, was resurrected by Marvin Feldman, a prominent Ohio insurance agent and industry authority, in 2006. Feldman notes in an accompanying commentary that he was unable to identify the original author, and while the article can be found in a number of publications and websites, none of these sources cites an author either. Feldman also acknowledges he had to reword some of the article because the original syntax reflected a different era. Still, the financial and social concepts at the heart of life insurance remain relevant to the challenges and aspiration of today’s world.

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5-MINUTE FINANCIAL THOUGHT:
Suppose you could swap all your financial assets in exchange for a contract that guarantees you a risk-free return for the next 50 years. What is the minimal annual rate of return (after inflation, fees and taxes) you would accept in order to make this exchange?

Total-Return Swaps, Unrealistic Expectations, And Why Experts
Will Only Guarantee 1% Annual “Real” Returns (A 5-Minute Answer)

Total-Return Swaps
The hypothetical trade in the 5-Minute Financial Thought is a simple form of a total-return swap. In a total-return swap, one party receives a guaranteed payment in exchange for surrendering all returns generated from their non-guaranteed assets. Sophisticated versions of total-return swaps are used by financial institutions, particularly hedge funds.

When they come to agreement, the terms of the total-return swap indicate the expectations and risk tolerance of both parties. For example, suppose you would accept a guaranteed 6% annual rate of return. This means you feel the risks required to achieve a return greater than 6% are not worth the value of the guarantee. In contrast, the institution or individual offering the 6% guarantee believes that the returns from your non-guaranteed assets will yield more than 6%. Researchers often use some form of total-return swap question when surveying investor expectations.

Unrealistic Expectations
It’s one thing to assess your risk tolerance within the framework of a total-return swap. It’s a completely different question as to whether most investors’ assessments of their risk tolerances and return expectations are reasonable. Consider the following:

The question asks for a minimal rate of return after inflation, fees and taxes. Historically, inflation has averaged 3% a year, and most experts would estimate that fees and taxes eat away another 2 to 4 percentage points. Thus, in any given year, these factors have the potential to reduce annual returns by 5 to 7%.

Ibbotson Associates calculates that, since 1926, U.S. stocks have averaged 9.8% on an annual basis. This means the average “real” return falls somewhere between 3 and 5%. (There are certainly other investment options beside U.S. stocks, but many financial analysts would say stocks have achieved the best long-term results of any asset class.)

With this background information, Jason Zweig, who writes a regular column in the Wall Street Journal, asked several prominent investment experts which guaranteed “real” return they would accept in a total-return swap. William Berstein of Efficient Frontier Advisors said he would accept 4%. Laurence Seigel, a consultant and former head of the Ford Foundation said 3%. For John Bogle, the founder of the Vanguard group of mutual funds, the number was 2.5%. Elroy Dimson, an expert on the history of market returns was even lower: 0.5%. In essence, the experts’ understanding of the risks and rewards seems in line with actual performance.

But what about non-institutional, individual investors? From the research, most don’t have a clue. A Vanguard survey from October 2009 found the median investor expects annual returns of 7.5%, but 15% of respondents expect annual returns of 15% or higher. Zweig cited another survey in which investors expected returns averaging 13.7% over the next 10 years.

Just 1%? Why?
As president of the Investment Fund for Foundations, David Salem posed the total-return swap question to several institutional money managers, asking them what rate of real return they would be willing to guarantee in exchange for a mixed portfolio of assets (containing stocks, bonds, cash and a small amount of commodities and real estate). The answer: 1%. Considering the way stock markets have rebounded in the past year, why is the guarantee so low?

Remember, the guarantee is based on a net return after inflation, taxes and fees. An institutional manager may be able to manage the effect that fees and expenses would have on the net return, but who knows about inflation and taxes? Stimulus spending and record deficits have many analysts worried about inflation. If the rate of inflation were to rise to 8%, it might require gross returns of 12% just to realize a 1% real return. And increasing tax rates would only make the challenge greater.

Because inflation is an unknown (and sometimes subjective) variable, and because taxes vary with individual circumstances, most reports of annual returns are not after expenses – they are not “real” returns. When individuals combine unrealistic expectations about returns with an ignorance of the costs associated with investing, they are setting themselves up for disappointment.

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In order to fully appreciate the impact of computers, you have to remember what life was like before them. In short, you have to be older than 60 – and remember a world where most receipts were handwritten, bankers calculated monthly loans from interest rate books in their desks, and complex mathematical calculations were performed on slide-rules.

It is impossible to overstate the degree that computers have revolutionized the use of numbers in everyday life in the past 50 years. Complex calculations have become commonplace, and lightning fast. Today, the only limit on the ability of computers to process mathematical information is the speed at which data can be entered.

However, for all their processing capacity, the usefulness of computer technology is dependent on a higher order of processing. Human intelligence is required to sift, sort and make sense of the vast array of information now available.

And while computer processing continues to expand exponentially (i.e., Moore’s Law), it can be argued that our ability to use it effectively is not keeping pace. Rather than providing insight and direction, the additional information is often making it harder to find the right answers.

An illustration of how human intelligence is trailing computer processing can be found in the use of computer programs to project retirement scenarios. Today, in just a few minutes, online calculators can deliver detailed reports that 20 or 30 years ago would have taken a team of math experts several days, or even weeks to produce.

But just because a lot of information can be generated in a hurry, doesn’t mean it will actually help you reach your financial objectives. It’s not that that the math doesn’t add up; sometimes the information simply isn’t relevant.

The Monte Carlo model: Great features, but…?
Ask a long-time financial professional to describe the earliest retirement calculators of 20 years ago, and the answer usually goes something like this: The advisor met with the client, and together they established several parameters for projecting the future. These variables typically included an annual deposit amount, an estimated rate of return, how many years until retirement, and how many years of estimated retirement. Using these four variables, it was possible to project an accumulation amount that would be available at the onset of retirement, and how long it would last. The next level of sophistication added projections for inflation and taxes, and perhaps included projected Social Security payments as well.

While these variables were believed by both the advisor and client to be realistic, they were nothing more than educated guesses about the future. Further, these early calculations were static – the amounts deposited remained the same each year, as did the rates of return and other factors, like taxes.

To reflect the fluctuating nature of investment performance, computer programmers began in the past decade to build uncertainty models into their calculations. Instead of one projected result, these retirement programs attempted to show a range of possible outcomes, and identify which outcomes were most likely to occur. These analytical programs, based on probabilities and incorporating future uncertainties, have infinite variations, but are commonly referred to as Monte Carlo programs.

If you type in the phrase “Monte Carlo calculators for retirement planning,” Google will deliver almost 50,000 entries. You can find free customer-friendly calculators provided by the largest financial institutions, or custom-designed models built by academics. Some deliver an answer by filling in a 5-question survey, others require more in-depth participation. Monte Carlo programs are everywhere, and working from the data that is inputted, Monte Carlos can tell you a lot of things.

A Monte Carlo can tell you the historical likelihood of achieving your objectives, usually expressed as a percentage (“historically, you have a 78% chance of reaching your objectives”). It can provide a “date of ruin,” i.e., when your money runs out. It can help you modify your results by changing your variables (adding more money, assuming less investment risk, estimating a lower inflation rate, etc.). In theory, this information should give you some reference points for making your financial decisions. Do you need to save more (or less)? Should you adjust your accumulations for more (or less) risky financial vehicles?
But while this information may be helpful in getting an individual to focus on the task at hand and take action (a good thing), there are several inherent flaws with Monte Carlo calculators.

Educated Guesses Are Still Guesses
Much of the data that generates a Monte Carlo calculation are guesses. The resulting projections must be guesses as well. The disclaimer at the bottom of a popular online Monte Carlo program candidly acknowledges this:

IMPORTANT: The projections or other information generated by the (company) Investment Analysis Tool regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. The simulations are based on assumptions. There can be no assurance that the projected or simulated results will be achieved or sustained. The charts present only a range of possible outcomes. Actual results will vary with each use and over time, and such results may be better or worse than the simulated scenarios. Clients should be aware that the potential for loss (or gain) may be greater than demonstrated in the simulations.

It’s almost like a disclaimer from a psychic hotline: This service is for entertainment purposes only. The numbers generated by the Monte Carlo program might be interesting, but please don’t think they are accurate.

Individual Results Cannot Be Derived From Large Numbers
Monte Carlo projections are based on the statistical histories of large groups of people and investments. These piles of data generate things like probable life expectancies and average rates of return. But you are not a large group, and neither is your money. You are an individual that holds specific financial assets, and as an individual it is impossible for you to replicate the projections a Monte Carlo program might generate. Carl Berdie, CLU, author of “Insure or Invest: Which is Best?” in the November 2009 trade publication Life Insurance Selling says this distinction between individual results and group averages is another reason Monte Carlo projections miss the mark:

“It’s impossible to die exactly at your life expectancy. If you plan at age 60 for 20 years of additional life, when you are at age 80 (when 60-year old males are supposed to die), you have a life expectancy of about eight more years. At 88, you have almost five more years to live. Thus the life expectancy model is a moving target that will never be accurate. Life expectancy is based on the law of large numbers and can’t be brought down to the individual level.”

If the variables used to generate Monte Carlo projections are “moving targets” in constant flux, then constantly fluctuating projections aren’t really worth much. It’s like having a wobbly sight on a gun; you can’t shoot straight if your view of the target is constantly out of focus and shifting.

Answering The Wrong Questions
James S. Welch, Jr., is a “designer and implementer” of computer software programs with 50 years of experience. He is listed as the principal architect of a free, online, “alternative” retirement calculation program that claims to resolve the shortcomings he sees in Monte Carlo programs. In an article titled, “A critique of Monte Carlo Retirement Calculators,” last updated October 3, 2009, Welch offers this assessment:

The most serious problem is that conventional Monte Carlo retirement calculators answer the wrong question. The retirement question they attempt to answer is:

• When will the money run out?

The relevant question is:

• How much money can I spend each year so that my money will last a lifetime?

At first, Welch’s comments may seem like a simple matter of semantics. But it also reflects the “sift, sort, and make sense” function that must accompany the processing of information. If the data doesn’t answer the right questions, configuring it is a waste of time.

Making Technology Work For You
In the area of personal finance, computer technology can sometimes be the tail wagging the dog. We get so excited by all the new things we calculate, illustrate and collate that it makes us giddy. But step away from the distraction of eye-catching pie charts and one-page plan summaries updated in real time. Suppose someone told you the best way to prepare for retirement is to make some guesses, evaluate those guesses using averages derived from other peoples’ experience, then accept answers to questions you are not asking. Would that make sense? No.

But the problem isn’t with the numbers or the calculations. It’s the philosophies and assessment procedures that need to be fine-tuned.

You don’t want to feel like a number. You don’t want to project your future on mere guesses. You want strategies that will work for you, not ones that have a 75% success ratio with other people. And you want an approach that addresses your financial objectives, instead of a pre-determined list. To do those things, you need good sift-sort-and-make-sense intelligence – either from yourself or your trusted advisors.

Today, every financial professional has access to great computer programs. But who can handle the critical human elements that will ultimately make the difference in reaching your financial objectives? It’s the human element that determines how well technology works for you.

WANT TO MAKE TECHNOLOGY WORK FOR YOU?

GET THE INTELLIGENCE YOU NEED TO CONTROL THE PROGRAM BY TAPPING INTO OUR “HUMAN RESOURCES.” WE HAVE THE PERSPECTIVES TO MAKE SENSE OF THE MATH.

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A November 11, 2009 article in the Wall Street Journal titled “529 Plans – More Parents Are Becoming Dropouts” notes diminished participation in what “have been pitched as the ultimate college savings vehicle.”

In brief, 529 accounts allow investors to contribute after-tax dollars into an account that typically offers a range of mutual funds and other investments. Distributions and earnings from the account are tax-free as long as they’re used for higher education. 529 plans are sponsored by states, and their investment options and fees can vary widely.

Why the decline in participation? There are several external factors: Many individuals have experienced a decline in their ability to save, due to unemployment or underemployment; they just don’t have the money to save. In addition, the stock market collapse triggered some high-profile fund implosions, complete with accusations of mismanagement, exorbitant fees and lawsuits.

The nature of government programs
But the internal design factors of 529 plans may also account for the decline in participation. Like many other government-sponsored savings programs, 529s are singular, stand-alone vehicles that “don’t play well with others” from a financial standpoint. These government sponsored programs create a separate bucket with a new number or acronym – IRA, 401(k), HSA, 529, etc. – and once the money goes into the bucket, it is expected to leave the bucket under very specific circumstances, such as retirement income, medical expenses, or a college education. It is difficult to transfer funds from one bucket to another, and penalties are assessed for any alternative use of the funds. These restrictions can make it difficult to integrate a government-sponsored plan into the larger financial picture, especially when money is tight.

A tax benefit, but at what cost?
The principal incentive with government-sponsored savings plans is usually some form of tax break. But as the Journal article noted, “in today’s jittery investment environment, some consumers are forgoing the tax benefits of a 529 to retain the flexibility to use the money for whatever they wish.” Tax breaks are legitimate financial incentives, but especially in tight economies, many consumers are finding that financial flexibility and control hold a stronger attraction. As Michael Singer, a 49-year-old teacher who recently lost half of his value in a 529 account, told the Journal, “Any new money going to my kids’ college education is going into something that I manage myself.”

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Is this a bull or bear market?

It depends on your perspective.

The Standard & Poor’s 500 stock market index is a mathematical calculation of the collective value of selected U.S. stocks. On March 9, 2009 the Standard & Poor’s 500 Index closed at 676.53, its lowest closing value in well over a decade. On June 15, the same stock index finished at 923.72, a 36.5 percent increase in a little more than three months. Since financial analysts often identify a bull market as one in which values rise more than 20 percent over a previous low, the recent run-up certainly seems to qualify as good news for stock market investors. Except…

As the retirement planning website dshort.com succinctly reported on June 15, 2009, “The S&P 500 is 36% above the March 9th low, but 41.2% below the October 2007 high.” A bear market is usually identified as one where values are 20 percent below a previous low.

So Is It A Bull Market Or Still A Bear? 

Yes.

Which means…it may be a secular bear market.

A “secular market” is defined as one where the long-term trend is up or down (i.e., bull or bear), but punctuated by periods of significant counter-trends. A secular bull market will include some bearish periods, a secular bear market will still have some bullish moments.

According to investopedia.com, secular market trends since 1900 have lasted from 5 to 25 years. During this time there have been three secular bull markets and three secular bear markets. The last secular market was a bull – the long-term trend was upward – and began in 1983. When did the bullish trend end? It depends on your perspective. Some sources will say 2000, others point to 2007. One of the characteristics of secular trends is that it takes awhile to identify them.

An Analysis of Secular Bear Markets and Secular Bull Markets since 1900, issued by amateur-investor.net in June 2009, identifies the secular bull and bear markets using S&P 500 data. But the time period from 2000 forward ends with a “?”; in other words, after nine years there’s still no conclusion on whether the long-term trend is up or down.

Statistics may accurately represent historical events, but still need a framework in which to interpret them in order to be useful. The perspective matters as much as the math.

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In any election, at every level, the basic issue presented to voters is, in some fashion, a question of whether to stay the course or make a change. 
 
When the vote is between candidates, one (often the incumbent) is a proponent of staying the course, continuing things as they are, while the other candidate offers a change – a new list of priorities, a new way of doing things. When the vote concerns an issue (taxes, public funding, laws) the decision is still whether things should stay the way they are or be changed. How you decide to vote depends on your perspective. Your decision to stay the course or pursue change doesn’t really hinge on facts, but on how you interpret the facts. 
 
Similarly, your financial decisions are really based on your financial perspective. And just like a voter, you must decide: should I stay the course or is it time to make a change?  

A New Direction

Because of the ongoing economic crisis / turmoil / downturn / depression, many people are looking for fresh financial direction. They want someone to help them stop the losses – the loss in their retirement account or stock portfolio, the loss in their real estate values, the loss of their job.

The losses people have experienced are facts. But before you make another financial decision, you may want to first reconsider your financial perspectives. While a financial loss may be an indicator that some things need to change, the specific actions to correct the situation depend almost entirely on your financial philosophy.

In a segment of life that seems to be dominated by mathematical data, the idea of looking first at your “financial philosophy” – whatever that is – may sound a bit “out there”. For many, their overriding financial philosophy is pretty simple: “I don’t care much about the ideas; I just want to do whatever makes the pile of money bigger.” But because mathematical assessments can only be made about the past, you can’t make future decisions based solely on which decisions produced the biggest pile last year, or last week. Instead, you need a financial perspective that can interpret the events from the past in a way that gives some direction for the future.  

Are The “Incumbent” Financial Philosophies Still Valid? 

Historically, the past three decades produced several significant trends that influenced conventional financial thinking. As a result of recent events, each of these developments, once thought to be almost a “sure thing,” is receiving skeptical scrutiny.    

As values have plummeted in a manner not seen since the Great Depression, people are asking… 

Is The Stock Market Worth the Risk?

After three decades of trending upward in a steady, profitable course, it was common for financial observers to conclude that the financial markets offered the greatest opportunities for investment reward. And the expansion of the mutual fund industry meant even small investors could reap big-time profits.

However, the steep declines since the all-time highs in October 2007 have left many people reeling. Investors may have always known that returns aren’t guaranteed, they may have even experienced periodic short-term losses. But the majority of investors never expected to see 30% to 50% of their account values wiped out in one year. Very swiftly, planning for next year’s retirement became planning to keep on working, and hoping for enough time to recover from the losses.

As real estate values have declined, and foreclosures continue to glut the market, people are asking…

Does It Still Make Sense to Invest in a Personal Residence? 

The realtor’s mantra is, “Your home is your greatest asset.” Buy in with as little down as possible; use the appreciated equity to keep trading up. It wasn’t unusual for a $5,000 down payment on a starter home to result in a $1 million mansion 10 years later. And if you didn’t use the equity to trade up to a larger residence, you could always open a home equity line of credit to tap your gains.

Every part of this scenario worked – until the economy slowed. Defaults and foreclosures started to pile up, and housing values started to level off, and then drop. In a flash all that equity vanished – poof! For some, the loss has turned them upside down – they owe more than the house is worth – and they face two choices, neither of them good. They can continue making mortgage payments, knowing it may be years before the payments result in any equity. Or they can simply walk away, taking a hit on their credit history and losing whatever they had invested.       

As employment has become more tenuous, people are asking…

Should I Keep Maximizing My Qualified Retirement Plan? 

The conventional wisdom was “a path to a bountiful retirement was through maximum contributions in an employer’s 401(k)”. The tax deduction on deposits and the tax deferral on the earnings could make for some gigantic long-term compounding opportunities. With automatic withdrawals and loan provisions in many plans, it was easy to keep pouring in the maximum from each paycheck, and take some out for emergencies. And savvy investors didn’t have to accumulate years of service or wait until age 65 for a pension – retirement could happen on your timetable.

But a few things misfired. It turns out almost no one was a savvy investor – not the employee who asked his co-workers for advice or the professional money manager. And many of the outstanding loans became due in full when employment was terminated. For some who lost their jobs, their only financial resource was their retirement account, and many withdrawals resulted in income tax penalties.

As budgets get tighter, more people are asking…

How Much Debt Should I Carry? 

Credit is the grease of commerce. It allows people to obtain things now and pay for them over time. The use of credit makes people homeowners – and business owners – sooner. For manufacturers and service providers, it boosts sales – of cars, computers, office equipment, travel, everything. Smart and industrious entrepreneurs have used credit as the springboard to turn great ideas into fabulous fortunes.

Of course, there’s also the recognition that your ability to borrow is dependent on your ability to repay. You can’t borrow indefinitely – at some point, you have to pay it back. Or you have to declare bankruptcy and start over. Right now, there’s a sense that many Americans have reached their credit limit.

And What About the “New” Financial Candidates? 

As some of the incumbent financial philosophies have staggered, a host of options have emerged. Many of these ideas aren’t new, but circumstances have given them renewed relevance.

The fallout from the declining markets, rising unemployment and the credit crunch have resulted in greater government involvement in what once was considered the “private sector” of Americans’ financial lives.

• There has been a massive infusion of government stimulus spending and bailout assistance from AIG and TARP to Chrysler and GM.
• As the United States government takes a more direct role in “managing” the national economy, the short-term result appears to be increased government borrowing and higher deficits, along with greater government regulation over products, transactions and compensation.
• The administration is actively seeking to re-structure the tax code, offering incentives and/or credits to home and car buyers, re-evaluating the estate tax and considering new “sin” taxes on items such as beer and soda pop.
• Government is also looking to reform the health care system, including a government-sponsored insurance alternative, and digitizing the medical record system.

Regardless of your political persuasion, these government initiatives represent potentially significant changes in the financial landscape – for businesses and individuals. As Jon Meacham and Evan Thomas put it in their cover article for the February 16, 2009 issue of Newsweek: We Are All Socialists Now.  If that’s true, what impact will it have on your financial philosophy?

Is it Time For a Change? It Depends 

Is there a new economic paradigm? Have the losses and government intervention fundamentally changed the rules and strategies for prosperity? As was mentioned at the beginning of this article, how you vote depends on your perspective. For some people, nothing has changed, even with all the apparent economic turmoil. A value investor probably still sees great opportunities in the stock market. A person looking for a home might find fantastic bargains among foreclosures. And a true free-market libertarian already felt the United States economy was essentially socialist – the only difference was the degree.

For others, the events of the past 18 months are forcing them to re-evaluate their approach to financial decisions. A June 2, 2009 Wall Street Journal article titled “Americans Get Even Thriftier as Fears Persist” begins with “Americans are saving more of their paychecks than at any time since February 1995.” “New Horizon, New Behavior,” a survey from Barclay’s Wealth released on June 15, 2009, reported that 68% of wealthy investors are staying out of the stock market – even though 88 percent believe there are profitable opportunities – because they can’t tolerate the risk of loss. As for the possibility of the United States becoming socialistic, a March 26, 2009 Washington Post article reported that many college graduates “now see the government as an employer of choice.”

So…Even though things have changed, you can still make a strong case for staying the course – or making a change. It all depends on the financial philosophy you use to interpret the events.

Times May Change But Good Philosophies Are Timeless 

It’s quite likely that many of the people who feel whip-sawed by the current economic shake-up are those who believed that financial conditions were static – what was happening now would continue in the future. They saw the stock and real estate markets always going up, their employment conditions stable, and their access to credit infinite. If so, that was a faulty interpretation.

Financial history is full of ups and downs. While the events of the past 18 months have been somewhat unusual in their severity, they are not uncommon; in fact, the peaks and valleys occur regularly.

One of the characteristics of a good financial philosophy is that it provides insight and direction to make it possible to thrive in all circumstances – not just the particular trends of the moment.

For example, people with a timeless financial philosophy:

• Have guidelines for their participation in the stock market or other investment opportunities. This doesn’t mean the guidelines are guarantees. Rather, it means there is recognition (and preparation) for what can happen, both positive and negative.
• Understand the psychological value and true financial costs of home ownership. Besides price of the home and size of the mortgage, owning a home consists of other benefits and liabilities. There may be tax deductions to consider, as well as overhead costs like insurance and property taxes. Profitable home ownership takes all these issues into account.
• Know when borrowing can multiply their wealth – and when it should be avoided. Just like a home is more than the price and the mortgage, borrowing is more than the interest and length of term. It depends on whether the borrowing is for emergencies or wealth-building. And even those who are debt-free and not currently looking to borrow should be sure they have access to credit.
• Balance their retirement savings against emergency and liquidity needs. Much of the hype of qualified retirement plans was built on “Plan A” premises – where everything goes exactly as planned. But history shows there’s often a need for a Plan B.

If the events of the past 18 months have undone your financial progress, now is a good time to evaluate whether you would be better served by an adjustment in your financial philosophy. Not only that, it might also be a good time to ask the same questions of the financial professionals you’ve asked to help you with your financial programs, and see if their financial philosophies are ones that work – and are in line with yours.

• ARE YOUR FINANCIAL PHILOSOPHIES TIMELESS?
• HAVE THEY WITHSTOOD THE UPS AND DOWNS THAT ARE CHARACTERISTIC OF ECONOMIC CYCLES?

• ARE THEY DESIGNED TO SUCCEED UNDER ALL TYPES OF ECONOMIC CONDITIONS?

 

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“Unfortunately, no one can be told what the Matrix is. You have to see it for yourself.” – Morpheus, from The Matrix

In some circles, a million dollars is chump change; it takes only minutes for our government to spend that much, and big corporations have many millions pass through their hands in one day – even during a recession.

But for most individuals, a million is still a big number when it comes to their personal finances. For a long time (probably since the beginning of the 20th century), becoming a millionaire has been a financial milestone for Americans. Even though inflation has dramatically changed the purchasing power of a million dollars, the number is big enough to still have significance. If you have account balances – in the bank, in your portfolio, in your 401(k) – that add up to $1,000,000, prevailing wisdom says you’re doing pretty well.

There are a lot of real-life variables involved in accumulating $1 million: career choice, physical health, personal lifestyle, geographic location, the general economic climate, even luck. Ask 10 millionaires for the key ingredients in their success, you’ll probably get 10 different answers.

The real-life variables probably have the greatest impact on whether or not someone will become a millionaire, but some of the mathematical variables – and the conclusions that can be made from them – are interesting as well.

Entering the Million-Dollar Matrix
There are three mathematical variables involved in accumulating $1 million:

• Time
• Amount deposited; and
• Rate of return

These three variables are interrelated. The Million-Dollar Matrix shown below is a way to illustrate how changing one item can speed up or slow down one’s progress toward reaching the million-dollar milestone. And a deeper look indicates that different variables have greater importance at different points in the matrix.

Here’s an example to help you use the matrix. Suppose you want to know the monthly deposit that would be needed to accumulate $1 million in 20 years. This information is found in the second shaded column from the left (the one that says “20 years” at the bottom). If you earned a steady annual rate of return of 8% for the entire 20-year period, a deposit of $1,686 would be required each month to realize a $1 million accumulation. If the projected rate of return increased to 12%, the deposit requirement would decrease to $1,001/mo. If the projected rate decreased to 4%, the deposit would have to increase to $2,717/mo.

Remember: The Matrix is not real life – it’s just math. In real life, the financial variables aren’t static. Rates of return don’t stay the same year after year, so any comparison to actual returns is going to differ (although average rates of return over a specific period will correlate with a steady rate of return over the same time period). The matrix doesn’t make any recommendation about what type of financial vehicles will be used to generate these projected returns, doesn’t factor in any investment risks that might be part of financial instruments that offer the possibility of higher rates of return, and doesn’t consider how taxes might impact any of these decisions.

However… the math of the Matrix prompts some interesting thoughts about accumulation. Such as:

The shorter the time period, the greater the emphasis on the size of the deposit. Look at the 5-year column. If you’re starting at zero, and plan to accumulate $1 million in 5 years, it’s all about the size of the deposit. Sure, there’s a difference between depositing $12,123 each month at 12% and $15,835 at 2%, but the 12% earning deposit requirement is a 23% reduction over what’s needed with a 2% annual rate of return. Compare that spread with the 12%-2% difference at 40 years: $84/mo. is 94% less than $1,359/mo.

Look at the comparisons between the 2% and 12% annual returns at the 10- and 15-year periods. While the monthly requirement is almost halved, you still must consider whether the additional investment risk required to earn 12% per year would be worthwhile, especially for extended time periods. If you choose to project a lower rate of annual return (say 6%), the deposit numbers don’t move very much. At any time period less than 20 years, the main ingredient in accumulating $1 million is funding. You must be able to save a lot of money in a relatively short period of time.

With longer time periods, the challenge is consistency, both in deposits and rates of return. As the time period gets longer, the deposit required gets smaller and increased rates of return deliver exponential results. Less money can do more when the time is long and the return is high.

But in longer time frames, it’s easy to see how real-life issues could undo the math. Question: For a responsible, future-oriented 25-year-old, which would be harder: saving $84/mo. for 40 years, or earning 12% a year for 40 years? Answer: Both.

Can you imagine making a monthly savings deposit for 480 months and never missing a payment? Can you imagine an investment that delivers 12% annual returns for 40 years without a hiccup? Math says it’s possible, real life says no. (See the blog post “Buy-and-Hold: Hanging On, or Gone for Good?”)

If the higher long-term rates of return are not realistic, this means 40-year savers should set aside more than $84/mo. At a 6% annual rate instead of 12%, our typical 25-year-old needs to save $500/mo. – for 40 years. That’s a big challenge, for anyone, let alone most 25-year-olds. How many people keep anything – the same job, the same house – for 40 years?

If you think you’re getting a late start on accumulation, be cautious about “catching up” by seeking higher returns. According to the Employee Benefits Research Institute’s 2009 survey, released April 16, 2009, almost half of American workers 55 and older reported their savings and investments were less than $50,000 – and 30% said they had less than $10,000. These are people with a short accumulation horizon, and most of them aren’t close to accumulating $1 million.

Given their circumstances, some older accumulators may feel their only hope is to swing for the investment fences, hoping to hit a financial home run. But remember the math is in the Matrix. A few percentage points in higher returns isn’t going to deliver as much impact as figuring out how to set more aside. Further, if you lose money attempting to achieve a higher return, you have a shorter time to recover the loss.

It’s worth remembering that most Americans at all income levels currently experience their peak earning years between the ages of 45 and 54. This peak earning period has steadily increased over the past 20 years, and there are indications this trend will continue. So, while the monthly deposit to achieve a $1 million dollar accumulation in a short time may seem steep, it’s also possible that your ability to save larger amounts may be ramped up as well.

Where Are You in the Matrix?
Even if the Matrix isn’t real life, the math gives you some things to think about.

As mentioned earlier, saving starts with funding. Once they understand the format, almost everyone who enters the Matrix gravitates toward a time frame that matches their current age and projected retirement. A 40-year-old checks out the columns for 20, 25 and 30 years. A 55-year-old looks at the 10-year column, or if he doesn’t have much savings, scans the 15 and 20-year columns. The rate of return matters, but mostly, you’re checking to see if you can match the required deposits.

This is a natural and productive starting point. “How much are you saving each month?” is a pivotal question, and the Matrix gives you some perspective on whether you ought to be looking to save more, depending on your objectives and circumstances.

Next, there should be a consideration of what you believe is a reasonable rate of return. During the boom years in the financial markets over the past two decades, it was common to believe averaging double-digit annual returns was realistic. Now…well, most people are less optimistic. It’s not that double-digit returns are out of reach, it’s the awareness that they may also be accompanied by double-digit losses that tends to dampen expectations – or bring them to more realistic levels.

Assuming a lower rate of return means higher funding levels will be required to reach your objectives. That can be a bummer, because more money allocated to saving for the future means less allocated to spending today. However, overfunding your financial objectives and underprojecting your rate of return is better than the reverse – underperforming and underfunding would be the worst of both worlds.

Making The Matrix Work For You
In terms of accomplishment, accumulating $1 million by saving is still a big deal. Most millionaires didn’t become millionaires by saving. They did something, owned something, built something, or sold something to acquire their millionaire status. So while it’s mathematically possible for a middle-class American to save his way to $1 million, it’s a project that requires diligence and discipline – and one that will most likely take a minimum of 15-20 years to accomplish.

If you’re looking for help in the million-dollar Matrix, ask yourself this question: Would you rather work with someone who helps you find a way to

a.)    Save $2,568/mo. for 25 years at 2%, or
b.)    Save $1,001/mo. for 25 years at 12%

The answer to this question speaks to our perception of that loosely defined term “financial planning.” Most often, the phrase is used when discussing investment strategies, but there are other possible applications. For example, planning could include strategies for debt structuring, budgeting, tax planning or risk management. If those strategies make it possible to save more money, they are certainly just as valuable, maybe more, than those that focus on trying to squeeze out higher returns.

In general, it is easier, and less risky, to earn 2% than 12%. If a financial professional can show you (through better management of debt, expenses, taxes, etc.) how to meet the demands of the Matrix through higher deposits at lower risk, your chances of succeeding are better than the reverse. The TV stock pickers and newsletter writers get a lot of press when they hit a home run, but you may find that financial efficiency combined with steady, conservative returns gets the job done just as well.

After all, you don’t care where you enter the Matrix. All that matters is if you leave with a million dollars.

WHERE ARE YOU IN THE MATRIX?

IS YOUR FOCUS ON HIGHER RETURN, OR MORE SAVING?

COULD YOU BENEFIT FROM GREATER FINANCIAL EFFICIENCY?

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LISTEN: Audio mp3 (22:42 min)

The bottom-line objective of any individual financial program is to provide an ongoing stream of income to meet the necessities and pleasures of life.

Market values for different assets might add up to significant net worth, but net worth doesn’t buy groceries, pay the bills or take you out to dinner; your income does. People pray “give us our daily bread,” not “give us asset appreciation.”

This post emphasizes the primary position of generating income in your financial programs, because income is what makes all other financial decisions possible.

How Long Can Your Human Asset Keep Paying Dividends?

When it comes to asset values, we know the numbers are ugly. How ugly?

• In the 2008 calendar year, the S & P 500 stock market index registered a 37% decrease, its worst calendar year performance since 1931. From January 1, 2009 to March 19, 2009 the index has declined an additional 15%.

• Meanwhile, the Federal Housing Finance Agency reported on February 24, 2009 that home prices dropped 8.2% from a year earlier, the largest annual decline on record since 1991.

• In total, the Federal Reserve reported that the wealth of American families plunged nearly 18% in 2008 – a loss of net worth estimated to be around $11 trillion.

But guess what? As securities and real estate markets have taken a pounding, another asset has returned to prominence. Featured on the cover of the March 23, 2009 paper version of Time magazine is the headline “10 Ideas Changing the World Right Now.” And according to Time, the No. 1 world-changing idea is…

…Jobs Are the New Assets.

That’s right; you – and your ability to deliver a steady income by working – are the “new” asset class that can make a difference during this down economy. Here’s an excerpt from the article, written by Barbara Kiviat:

“Houses and stocks – those were the things we paid attention to, the things that gave us the confidence to be good American consumers (Hello, home-equity lines of credit). At the same time, the percentage of income we saved dropped and dropped and dropped – until, thanks to the power of credit cards and other debt – it went negative in 2005. That was neatly explained away by the ‘wealth effect’: we spent money we didn’t have because we felt – and technically were – richer because of our assets.

All the while, we blissfully ignored a little concept economists like to call human capital. The cognition you’ve got up there in your head – your education and training – it’s worth something. We can extract value not just from our homes and our portfolios but from ourselves as well. The mechanism for extracting that value? A job. ‘The income you earn from working is like the stream of interest income you might get from owning a bond,’ says Johns Hopkins University economist Christopher Carroll. ‘Think of it as a dividend on your human wealth.’”

While it might make for nice headlines, identifying human capital as the core of financial prosperity isn’t a new idea. From ancient cultures that penned proverbs extolling the value of work (“Do you see a man skilled in his work? He will stand before kings…”) to 20^th century champions of free enterprise and capitalism like Ayn Rand (“Wealth is the product of man’s capacity to think.”), human capital has always been recognized as the key ingredient in creating wealth. Real estate doesn’t gain value on its own – it has to be developed. An increase or decrease in stock prices ultimately reflects the decisions and productivity of the people in the company – both the employees and owners.

Given the media infatuation over the past decade with other assets, the article provides some much-needed financial perspective. Too often the most overlooked or undervalued financial asset is you and your abilities. Your ability to produce a regular income makes you a powerful dividend-paying asset, and it’s the type of asset that satisfies the basic objective of an individual financial program: to provide an ongoing stream of income to meet the necessities of life – and hopefully afford some of the luxuries as well.

When stock market and housing values were soaring, some people lost this focus on income production, because prevailing sentiment said you could always turn value into income at a later date by selling or borrowing against the assets. But when values decline and borrowing standards tighten, the assets don’t have the same convertibility.

Building Up Your Human Capital
This sounds obvious, but in a time when other asset classes are faltering and the economy is struggling, steady income from a job is critically important to your long-term financial well-being. And like any other business that wants to remain profitable, your human capital must remain competitive in the market place. You may need to consider an investment in continuing education, or an upgrade in your technology skills. And “under-employment” – i.e., working in a position below your qualifications – may be better than not working, because of the future opportunities that may arise from connections with other productive people.

But even if you remain employed, there are other threats to your human-capital dividend production. Your human capital doesn’t last forever. At some point, you may get tired or break down. Eventually age takes some or all of your productive capacity. So unless you die young, it isn’t reasonable to expect you will remain fully productive for your entire life. This is the biggest financial challenge in using human capital to provide an ongoing income: At some point, there will need to be a transition from income/dividends from your human capital to income/dividends from other capital. But when?

The Longevity of Human Capital
The statistical realities of human capital in developed nations are eye-opening.

First, consider life expectancy. According to the Social Security Administration, a 40-year-old American male has an average life expectancy of another 37.28 years. (See Fig. 1 for life expectancies at other ages). And the older you are now, the greater your life expectancy – while an average 40-year-old male can expect to live until 77, an average 60-year-old male can expect to live to 80.

But there’s a distinction between being alive and being healthy enough to work. In most cases, people will not be able to work as long as they are alive. To account for this distinction, longevity statisticians have developed a Healthy Life Expectancy (HALE) calculation. HALEs (pronounced haleys), are defined as the average number of years that a newborn can expect to live in “full health,” and are used by statisticians to adjust life expectancies for the amount of time spent in poor health.

The World Health Organization (WHO) provides a HALE calculation for each country in the world. In the United States, the current HALE is 67.0 years for males and 71.0 years for females. When compared with current life expectancies for newborn Americans, the difference is 8 years for males and 9 years for females. From this data, it might be possible to consider average human capital to be “used up” 8 or 9 years before the end of one’s life.

But this data is for newborns – those born today. Other current information, while not providing an apples-to-apples comparison with the HALE data, is even more sobering…

The following statistics come from reports issued by the Urban Institute in December 2008 and February 2009:

• About one-third of all Americans develop a health-related limitation in their fifties and sixties.
• Four in 10 workers in their fifties have jobs with some physical demands, which they might not be able to meet as they grow older.
• Even for workers in jobs that aren’t strenuous, health problems can keep many from working. More than a quarter of adults age 65 to 69 have a health problem that limits the work they can do.
• As a result, 37% of American workers do not retire on their own timetable, but rather are forced into retirement due to layoffs, illnesses or injuries.

In other words, human capital, while the key to all wealth production, is a fragile asset. It needs to be protected, and eventually, must be replaced by other assets.

Protecting Your Human Capital
Some of the best protection for your human capital is simple self-maintenance. Eating sensibly, exercising, and avoiding bad habits are not guarantees of a long HALE, but all evidence points to a clear correlation. Good health is essential to maximizing the value of your human capital. The longer you can produce an income, the greater the likelihood of financial security.

The rest of your human capital protection issues are best handled through insurance.

In the insurance business, there’s an old analogy that compares your human capital to a business machine that generates thousands of dollars in income per year. Considering its value, it makes sense to insure the machine (you) for direct damages, as well as coverage for lost income if the machine were broken or worse yet, if it were destroyed. Life, health and disability insurance exist to protect against the risks to your personal wealth-generating machine.

If you are unable to work due to sickness or injury, health insurance is designed to cover “repair” costs, as well as provide an ongoing income during the period you are “out of service.” If your injury or illness is more long-term, disability insurance helps supplement your lost income. And if you are no longer able to provide for your dependents because of death, life insurance is designed to provide assistance for final expenses and ongoing income.

Because a major medical incident has the potential to cause the most immediate financial damage, health insurance seems to be a front-and-center issue for workers, employers and politicians. But the current obsession with solving the health-care crisis shouldn’t obscure the need to address individual disability and life insurance issues as well.

Don’t Undervalue Your Human Capital
A lot of space in the popular financial press is consumed with dissecting the fallout from the decline in asset values. Experts are trying to determine when the stock and real estate markets will rebound. Individuals are trying to decide if they should continue to buy-and-hold or cash out. These are important issues and legitimate financial concerns because assets, cash, stocks, bonds, and real estate have a place in your financial life.

But perhaps current events are also helping to reshape their importance of these types of assets in relation to the essential position human capital holds in every individual’s financial program. Developing and protecting your human capital sets the stage for long-term financial success – in all types of economic conditions. More than any prognostication or rearrangement of your other assets, your human capital is the one asset most likely to carry you through tough economic times.

This awareness should prompt some assessment of the condition of your human capital.

• Should your human capital be upgraded through education or the acquisition of new skills?
• Is your human capital healthy, or should you implement a better maintenance plan?
• Have you adequately protected your human capital?
• Is now a good time to use other assets to improve your human capital?

WHEN OTHER ASSETS START TO SLIDE, YOU WANT TO BE SURE YOUR BEST ASSET IS ON SOLID GROUND. DOES YOUR HUMAN CAPITAL NEED AN “ASSET CHECK?”

A Longevity Annuity as “Income Insurance”

Here’s an intriguing financial transaction:
A 60-year-old man places a small portion of his retirement savings in an annuity that will produce a guaranteed income once he reaches an advanced age, say 85. Based on current assumptions, here are some details: On a deposit of $50,000, the annuity is guaranteed to pay $5,211 a month, beginning at age 85 – for the rest of his life – no matter what happens to interest rates or mortality costs in the future.

If you do some future value calculations, the rate of return of the $50,000 placed in the annuity seems pretty high; at 6% annual interest, it would take more than $1 million in assets to provide an equivalent ongoing income. But even over 25 years, $50,000 would have to earn an average annual return of almost 13% to equal $1 million. So how does a longevity annuity achieve this result?

One key feature: If the policy holder dies before age 85, the annuity expires without value. Heirs receive nothing.

As John Olsen, a Chartered Life Underwriter from Kirkwood, MO writes in the January 2009 issue of the trade publication Life Insurance Selling,

“Why would anyone buy such a thing? Why buy a policy that won’t pay him a penny for 25 years and if he doesn’t make it that long, he loses his entire investment? Sounds like a very bad investment.”

But Olsen goes on explain this annuity, known as an advanced life delayed annuity, or longevity annuity, is not an investment. “It’s a risk transfer instrument – a pure insurance play. The risk that the purchaser transfers to the issuing insurer is the risk he’ll run out of money at an advanced age (when he cannot expect to earn income).”

The structure of longevity annuities are not limited to deposits at age 60 and payments at age 85. Deposits can be made as early as age 40, and payments can begin earlier as well. Earlier deposits will generate higher payments. Payment at younger ages will result in lower monthly amounts.

Longevity annuities are relatively new products in the marketplace, but have received some surprisingly positive reviews from the popular press, all because of the guaranteed income feature. In a January 21, 2008, Money article, senior editor Walter Updegrave writes:

To my mind the concept behind longevity annuities makes a lot of sense. In effect it’s like buying a homeowners or health insurance policy that has a very large deductible. You’re insuring yourself against a catastrophic risk you can’t handle on your own – in this case, running out of money late in life – while holding your premium to a minimum.

You guarantee yourself an income to cover your spending late in retirement while leaving more of your savings available to you today (or available to your heirs if you die young). And you can comfortably spend down a greater portion of your savings earlier in retirement, knowing that those longevity annuity payments will eventually kick in.

Martha Hamilton, writing in the Washington Post (“Live Long and Prosper,” August 12, 2007), emphasizes the cost-effective way that insurance can handle the need for income later in life.

You buy insurance because you get protection from a possible disaster at a reasonable cost. Same thing with a longevity annuity. It’s insurance that you won’t end up living on nothing but Social Security if it turns out that there’s more life at the end of your money than money at the end of your life.

The Spend-Down Concept Behind the Longevity Annuity
In examples used to illustrate the financial effectiveness of a longevity annuity, the hypothetical policy buyer allocates between 5-15% of his/her current accumulation to a longevity annuity; a 60-year-old with a $1 million portfolio sets aside $50,000-$150,000.

Even though buying this “protection” decreases the overall account balance, having the longevity annuity allows one to “spend down” assets over a specific period of time instead of living only on interest or investment earnings and preserving principal. The insurance allows other assets to be spent more efficiently – in other words, more income is derived from the assets.

According to an online article from CNN/Money (money.cnn.com/retirement), putting 10% to 15% of retirement savings into a longevity annuity “provides roughly the same spending power as devoting 50% to 60% of savings to an immediate annuity, according to a paper by Jason S. Scott, retirement research director for Financial Engines of Palo Alto, Calif.”

Another Way to Accomplish the Spend-Down Concept
For those who own permanent life insurance, the spend-down concept may be executed even more efficiently. A life insurance policy that is in force in old age may have a significant value as a cash asset, as investors or financial institutions might be willing to make either payments or a lump sum to the insured based on a collateral assignment agreement – in exchange for rights to some or all of the life insurance proceeds at death, the insured receives money now. Having the life insurance available as a back-up (a whole life insurance death benefit may grow in value as you grow older), you are free to spend more of your accumulated assets.

Further, the insured does not have to live to a specified age to enter into a collateral assignment or life settlement agreement. If certain health situations precipitate the need for additional assets, an Accelerated Benefit Agreement will provide payments directly from the insurance company – no investor or other third party is needed. And of course, if the insured dies before needing to enter into a collateral assignment or similar agreement, the life insurance proceeds are distributed income tax-free to heirs.

If you understand the spend-down concept behind the longevity annuity structure and already have permanent life insurance, it might make economic sense to allocate 5-15% of your annual retirement income to permanent life insurance premiums. If you don’t have life insurance or find yourself uninsurable, a longevity annuity may be a suitable alternative.

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Here’s an easy riddle:

Up.
Down.
Down some more.
Up.
Down – in a hurry.
Up.
Up again.
Down, then up in the same day.

Who am I?

a. A schizophrenic
b. The stock market
c. A roller coaster
d. All of the above

Those answering “a” or “d” may want to consider professional help. Those answering “c” are having more fun than the rest of us. But for all those who quickly identified with “b,” keep reading. You may not be aware of the exact numbers, but you probably understand stock markets have been somewhat erratic in the past few months. They move up, they move down; there’s no significant trend. Combined with the fall-out from the sub-prime mortgage situation, some people warn that investors may be on the verge of sustaining some substantial losses. Historically, this would not be an unusual occurrence.  Recessions, depressions, and bear markets have been a regular part of the financial landscape just as much as upward trends, booms and bull markets.  History suggests that even with the ups and downs, the long-term returns are worth it so we have been conditioned to accept some losses along the way. But that doesn’t mean that financial losses – from any financial decision – are trivial things. Losing money is a concept that perhaps doesn’t get as much attention as it should in financial programs, but in many ways, the losses you incur may have a greater impact on your total wealth than the gains you make.  There are a number of mathematical examples to illustrate this idea.

Here’s a simple illustration.

Suppose you have $10,000 in some non-guaranteed financial vehicle (i.e., the account values may fluctuate). For three years in a row, the account delivers a 10% annual return. At the end of the third year, your account would have grown to $13,280. Here’s the progression:

Beginning balance: $10,000 Annual Return
End of Year 1: $11,000 + 10%
End of Year 2: $12,100 + 10%
End of Year 3: $13,310 + 10%

So far, so good. But let’s assume that in the fourth year you experience a loss, which while not desired, was not wholly unexpected.  The loss is 10%. Your account balance drops to $11,979.

Beginning balance: $10,000 Annual Return
End of Year 1: $11,000 + 10%
End of Year 2: $12,100 + 10%
End of Year 3: $13,310 + 10%
End of Year 4: $11,979 – 10%

Three out of four years you gained 10%, right? But consider the impact of the one bad year: The average annual return was more than halved. Through the first three years, the average annual return was 10%. But the one bad year reduces the average annual return for the four-year period to just 4.62%! In order to get back to averaging 10% a year, your investment must earn over 34% in the fifth year! Look at the math. Here’s what comes from five years of steady 10% annual returns:

Beginning balance: $10,000 Annual Return
End of Year 1: $11,000 + 10%
End of Year 2: $12,100 + 10%
End of Year 3: $13,310 + 10%
End of Year 4: $14,641 + 10%
End of Year 5: $16,105 + 10%

But if there’s a blip in the fourth year, making up for it in one year requires a steep increase.
Beginning balance: $10,000 Annual Return
End of Year 1: $11,000 + 10%
End of Year 2: $12,100 + 10%
End of Year 3: $13,310 + 10%
End of Year 4: $11,979 – 10%
End of Year 5: $16,111 + 34.5%

Even if you don’t try to recover the loss in one year, it would take six years of earning 13.5% each year to average 10% for 10 years – all because of one bad year.
Beginning balance: $10,000 Annual Return
End of Year 1: $11,000 + 10%
End of Year 2: $12,100 + 10%
End of Year 3: $13,310 + 10%
End of Year 4: $14,641 + 10%
End of Year 5: $16,105 + 10%
End of Year 6: $17,716 + 10%
End of Year 7: $19,487 + 10%
End of Year 8: $21,436 + 10%
End of Year 9: $23,579 + 10%
End of Year 10: $25,937 + 10%

Beginning balance: $10,000 Annual Return
End of Year 1: $11,000 + 10%
End of Year 2: $12,100 + 10%
End of Year 3: $13,310 + 10%
End of Year 4: $11,979 – 10%
End of Year 5: $13,626 + 13.5%
End of Year 6: $15,500 + 13.5%
End of Year 7: $17,631 + 13.5%
End of Year 8: $20,055 + 13.5%
End of Year 9: $22,813 + 13.5%
End of Year 10: $25,950 + 13.5%

In the conventional paradigm, the opportunity for increased return comes with increased risk. Thus, you could argue that increasing your annual return to 13.5% from 10% means increasing the risk by 35%. Remember, this is all the result of one bad year! Frankly, there’s very little market appeal to “loss prevention” – high rates of return grab headlines. (In today’s economic climate, how interested would you be in an accumulation vehicle that averaged only 4.62% over four years?) But if you really care about maximizing your wealth, you should expend some planning energy on avoiding
losses. The fewer setbacks, the less you have to “catch up.”

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