The Prosperity Blog

STATISTICS: Full of Sound and Fury, Signifying…What?

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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 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? 


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, 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 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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Will You Stay-the-(Financial)-Course or Make a Change?

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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.



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SELF-INSURANCE: A DIY Project that Doesn’t Make Sense

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One of America’s celebrated cultural values is individualism. We idolize people who are self-made, who rise up from their own bootstraps, who can say “I did it my way.” This individualism is part of the American dream, the idea that with enough effort and perseverance anyone can be anything, even President of the United States.

This glorification of individuality not only inspires us to pursue our dreams, it also makes for great marketing opportunities. The essence of the do-it-yourself (DIY) business is if anyone can be or do anything, why not do it yourself?

  • Want to build your dream home? You can do it yourself! (With our plans, our materials, our tools.)
  • Need a will or trust? Write it yourself! (Using our inexpensive legal forms and advice.)
  • Car trouble? Fix it yourself! (The parts store is just down the street.)
  • Don’t want to pay for a tax expert? File the returns yourself! (Download our program!)

From a popular culture standpoint, there can be an almost obsessive compulsion to find ways to operate independently. At the same time, this obsession can lead to a distrust of all large institutions – governmental units, banks, Wall Street, big corporations, even religious organizations. While some institutions perhaps deserve our distrust, it’s not always because they are big. Even in America, some large-scale cooperative efforts often yield better results than going it alone.

In Garrett Gunderson’s 2007 book, Killing Sacred Cows, the author takes on 10 prevailing financial strategies that he believes are harmful “myths” that diminish or deter prosperity. One of those myths is the idea that self-insurance is a profitable strategy.

“Are we better at providing insurance than the insurance companies? Can we provide equal benefits at a comparable price? If so, then we should become an insurance company for more than just ourselves. But if we cannot provide insurance as efficiently as an insurance company, then economically it is much less expensive to use insurance companies.”Garrett B. Gunderson, from Killing Sacred Cows

The “DIY” Version of Self-Insurance

In a nutshell, self-insurance is the idea that you can accumulate reserves of assets and resources so that you no longer need to pay an insurance company to protect you from the risks of life. If your house burns down, you have the money to rebuild it yourself. If your car is involved in an accident, you could make the repairs yourself – and pay for any damage you might have caused.

Self-insurance is the ultimate DIY financial project, and it has many advocates. From the perspective of the DIY financial gurus, insurance is something that should be bought in the smallest amounts possible, for the lowest price possible, and kept for the shortest time possible.

A prime example is self-insuring one’s life. The DIY philosophy is to buy the cheapest term insurance possible in order to devote as much capital as possible to accumulation strategies. In time, the accumulation balance will be large enough so as to make life insurance unnecessary.

Defined this way, self-insurance seems theoretically possible. But is it practical?

Self-Insurance Is Really No Insurance

Insurance is a method where individuals can share the financial risk by spreading the cost of potential loss amongst many people. But when you self-insure your home, you assume all the risk for any losses that might occur on the property. When you self-insure your medical expenses, all the bills that may result from an illness or injury will be paid out of your pocket. According to Gunderson, “there’s no such thing as self-insurance…You either have a way to transfer the risk of loss, or you retain that risk. Self-insurance is really no insurance.”

This might sound like semantics. If you decide you won’t buy homeowner’s insurance because you have a pile of cash, you don’t have insurance, that’s true. So maybe the real question is “if I have enough cash, why do I need insurance?”

Gunderson’s answer: “Producers (i.e., productive, wealth-building individuals) love insurance because it transfers their risk, and they know it saves them money in the long run.” In other words, the more assets and resources you have, the more you should want insurance, not want to get rid of it.

Gunderson provides the following example: “If a person owns a $1 million home and has no homeowner’s insurance, and also has $1 million in cash, where can he invest his cash in such a way as to keep his home protected?”

If he wants to be sure he has fully protected his home, how aggressively can he invest the money? If he is serious about protecting the value of his home, most likely his investment options will be limited to those that are very safe – and lower in rate of return. On the other hand, if a $2,000 annual premium for homeowner’s insurance means he can invest aggressively without fear, isn’t buying homeowner’s insurance a profitable financial transaction?

Risk vs. Return

Mainstream financial commentary often emphasizes the interrelated nature of risk and return in the context of a particular financial product. The typical comment is: higher return vehicles also come with higher risks. But there’s another paradigm for risk and return when insurance is involved. Using insurance to decrease risk in one area makes higher returns possible in other areas. Go back to the example of the homeowner with $1 million. With insurance, the homeowner can pursue greater opportunities and still know one of his financial risks (damage to his home) is covered.

Understanding this connection between reducing risk and increasing return through insurance, Gunderson concludes that the most effective financial arrangement is to buy as much of it as possible, and make it the best coverage available.

The Economic Value of Certainty

When people pool resources to share risk, one of the benefits is a higher level of certainty. Even if something unexpected or undesirable happens – i.e. your house burns down, you suffer an accident – you know you can respond. Knowing that you have decreased or eliminated the risk of financial loss provides a greater level of economic certainty. This certainty allows individuals to make better decisions, pursue bigger dreams, and focus on long-term results.

The value of economic certainty is not just an individual benefit. Entire societies benefit from economic certainty. Historically, tribal and feudal societies often languish at the subsistence level because of economic instability; when you are fearful that enemies or acts of nature may wipe out your wealth in an instant, it is hard to commit time and resources to any long-term projects.

In his 2000 book, The Mystery of Capital, Hernando de Soto declares that capitalism has triumphed in the Western world and failed everywhere else because of two cultural “insurance” factors: the rule of law and property rights. When people know the law will be applied equally and what they have is theirs to use, sell, or borrow against, the certainty allows them to focus on prosperity.

In an August, 2003 opinion paper, financial commentator Les McGuire expanded on the economic value of certainty:

“What people really want, when their minds are opened to the possibility, is the maximum value in every area of their life with as much certainty as possible. Even those who are self-proclaimed risk tolerant are kidding themselves. We should assume that every one has a risk tolerance of zero, meaning that if it was possible, [EDIT AUDIO] they would want every economic choice they ever make to work perfectly. No one really wants to lose money; they just think it is a prerequisite to making big money because that is what they have always been told. If they could make the same returns with no risk, everyone would want to.”

Now, More Than Ever, Insurance Matters

For many Americans, one of the consequences of the recent economic upheaval is the loss of insurance. Maybe they no longer have health insurance or group benefits through an employer; maybe they are currently out of work. Even if they are still paying their bills, these people are feeling the effects of economic uncertainty. They know they don’t have their risks covered.

At this point, some Americans feel that do-it-yourself reflex take hold. “Well, I’ll just have to take care of it myself.  I can do without cable TV; I can eat out less often. I’ll stop paying the premiums or reduce the coverage amounts for these three insurance policies and use some of the savings to create an emergency fund that will cover anything that might come up. I’m probably better off doing that than wasting money on insurance.”

Admittedly, there’s sometimes a difference between what’s ideal and what you can afford. But right now is not the time to try the do-it-yourself insurance program. You want as much of your financial risk to be shared by as many people as possible, not to have more risk put on you. There are a lot of productive things you can do on your own, but insurance definitely works best as a group effort.

That’s why now might be a good time to meet with us and review your situation. Our economic prosperity knowledge might give you options to rearrange your coverage, yet maintain a higher degree of economic certainty that can help you maintain your prosperity plans, and/or reposition you to succeed again.

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Financial Literacy Question: The long-term trend of financial markets

Conventional financial wisdom says the long-term trend of financial markets is generally upward. Even considering the declines over the past 18 months, what was the annual rate of return for the S&P 500 stock index for the 10-year period ending 3/31/2009? (Source: BTN research)

a. 5.2 percent
b. 3.4 percent
c. 1.2 percent
d. -3.0 percent

Answer: d.

The steep losses in 2008 wiped out all the gains from the previous nine years. According to BTN research, this 10-year period represents the eighth-worst decade for S&P investing since the S&P was established. (The worst 10-year period, from August 31, 1929 – August 31, 1939, registered total losses averaging -5 percent each year.)

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529 Plans Prove Problematic

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On April 14, 2009, the State of Oregon announced it was suing the national investment company responsible for managing its state-sponsored 529 college savings fund. Oregon Attorney General John Kroger alleges the investment company misled families into thinking they were making rock-solid investments for their children’s future. Instead, Kroger says one of the firm’s funds took undisclosed risks that resulted in a 36% decline in value for 2008. In a transcript from a report aired on NPR, Kroger says Oregon families “lost about $40 million, and we want our money back.”

(Actually, Oregon’s argument is not with the losses incurred, but that some funds supposedly structured to avoid or minimize market losses, particularly for those accounts that would soon be tapped to pay for education expenses, were not invested according to the objectives stated in the prospectus.)

As Jason Zwieg of the Wall Street Journal notes in an earlier March 21, 2009 article, Oregon is not alone in losing money. Of the 3,506 options in 529 college plans tracked by Morningstar, Inc. “93% fell in value over the past year, and 1,098 lost at least 40%.”

The main attraction of 529 plans is the tax advantages during accumulation and distribution, provided the funds are used for qualified education expenses. These benefits also come with restrictions: Investment choices are determined by the sponsoring state, transfers and/or exchanges are limited, and funds withdrawn for non-qualified reasons may be subject to both income tax and penalties.

Under normal circumstances, the combination of advantages and restrictions seems to provide substantial incentive for families to invest long-term for their children’s college education. But when the investment portion goes south, things unravel.

Families whose children are ready to enter college are finding their 529 accounts have sustained losses – their current balances are less than their deposits. For families whose financial situation has taken a turn for the worse (lost jobs, foreclosure, bankruptcy, etc.), education plans may be off the table. Yet deciding to access the funds often still means incurring penalties – along with the investment losses.

Other states are considering legal action against some of their plan managers. And even the IRS is trying to help. In an April 16, 2009 CNNMoney’s Carolyn Bigda noted “in light of the market’s recent volatility, the IRS is allowing savers in 2009 to switch 529 plans twice. Normally, you can only make a move once per year.”

According to Zweig, one of the shortcomings of the state-sponsored plans is that “the public’s faith in 529s appears to be based partly on a false premise: that state bureaucrats are good at managing other people’s money.” Clearly, the politicians were no better (or worse) than the rest of us when it came to investment acumen.

Beyond the assignment of blame, there’s a case to be made that 529s are susceptible to this type of turmoil because of the financial philosophy that underlies them. Many government-sponsored savings programs come with restrictions and incentives to encourage a narrow response from citizens. The 529 is designed for families to invest for college in a list of investment options chosen by state officials – that’s it. As long as everything goes well, both for the investment and the individual, the outcome is usually acceptable.

This compartmental approach – a specific plan with a singular purpose – often conflicts with the fluid nature of individual financial lives. At different times people want education money, or retirement money, or down payment money. And many individuals don’t have enough money to leave unused in separate compartments for several years – they would like to use the money they have for the reason that’s important right now. When things go wrong or priorities change, there’s often not enough money in one compartment, or there’s a prohibitive cost for redirecting the money to another compartment.

Given the choice, most Americans would probably prefer a tax-favored account with unlimited accessibility, similar to life insurance cash values – a larger pool of money available for whatever issues or opportunities may arise. Of course, well-intentioned politicians will fret that giving individuals an unrestricted tax-favored account may result in irresponsible spending. And considering the alleged abuses and failures of the financial professionals with 529s, the expectation may be tighter restrictions.

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The IRA: A Case Study in Present-Event Bias and Government Response

As a way to encourage individuals to save for retirement, the Employee Retirement Income Security Act (ERISA) of 1974 established the first Individual Retirement Accounts (IRAs), which eventually gave birth to other tax-favored retirement plans such as 403(b)s, 401(k)s, SEPs etc. The basic format for these qualified retirement programs is a tax deduction on deposits and tax-free accumulation; distributions taken in retirement are then taxable as ordinary income.

Over the past three decades, the ongoing logic for participating in qualified retirement plans has been straightforward. Because retirement is projected to be a period of lower income, distributions taken from IRAs or similar accounts will be taxed at a lower rate. Thus, receiving a tax deduction now (against a higher tax rate), and paying tax later (at a lower rate) is a financial advantage. At some time, every proponent of qualified retirement plans has intoned “You should have an IRA because you’ll be in a lower tax bracket in retirement.”

The financial advantage of IRAs was predicated on several present-event biases. First, that income tax rates would remain the same. Second, that retirement living expenses would be less than while one was working. Over time, both of these variables have changed. Income taxes have both increased and decreased for segments of the population. And retirement expenses, especially medical costs, have dramatically increased.In short, what was thought to be always the same has changed.

In response to these on-going changes, government has continually tweaked the rules, trying to keep IRAs and other qualified retirement accounts beneficial for participants. But often, even the best government responses are a step slow.

Take for example the recently implemented one-year reprieve in required minimum distributions (RMDs). In order to capture some of the tax eventually due on IRAs, previous IRA regulations required individuals over age 70½ to make mandatory minimum withdrawals from retirement accounts each year. But in December 2008, lawmakers suspended this provision for 2009, hoping to give investors a chance for their “accounts to rebound after a brutal year in the markets,” according to a February 11, 2009 Wall Street Journal article (“New IRA Law Bewilders Investors”). Instead of being forced to sell investments to take their RMD, account holders will be able to sit tight and wait for a possible recovery of their account values.

However, retirees still had to take their RMD for 2008 or face a stiff penalty from the IRS. Thus, in a year when major US stock indexes had declines of 30% or more, account holders still had to sell out at low prices to meet the RMD requirement. In other words, a one-year suspension of RMDs might have been more beneficial last year instead of this one.

In addition, the one-year RMD suspension has created both aggravation and confusion for account holders. Financial institutions holding IRA funds are scrambling to establish procedures for contacting RMD recipients (some are contacting only those receiving monthly checks, others not planning any contact until April, 2009, and still others are automatically suspending payments). Company administrators of 401(k)s are trying to determine if they first must amend their plan documents. In addition to the unresolved detail, there is uncertainty as to whether the reprieve will be extended for 2010.

Because IRA policy is often present-event driven, more changes – and more uncertainty – seem likely in the future. (Although assuming that government will “always” be a step behind might be a present-event bias as well. Maybe one day, the politicians will get it right in advance.)

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The Million-Dollar Matrix

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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 œ20 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.

Million Dollar Matrix

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 œcatching 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.
œHow 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 œfinancial 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.




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