How much does maxing out your IRA go towards your retirement?

I just received an email from my discount brokerage firm. Most of the emails I receive from these financial houses are oriented towards mutual funds and IRAs, because, of course, that is what they sell. It’s only natural. The only other emails I get is when I perform some transaction.

Today I got one that read “Even if you are only 10-15 years from retirement, you can still save a substantial amount in an IRA.” Is that true? What would the evidence suggest?

Looking at the table they included (as well as checking the IRS web site), contribution limits for 2013 are $6500. It’s possible to save up to your total earned income, but it’s capped at $6500, so let’s assume we manage to do that. Let’s also assume we get that maximum window they are telling us of 15 years. What is $6500 x 15 years? $97,500

But don’t forget, the increase the contribution limit each year to compensate for increased cost of living. They increased it by $500 from 2012, so let’s assume they will do that every year. Using a spreadsheet, you will find that saving $6500, then $7000, etc. for 15 years creates $150,000.

First of all, how useful would $150,000 be if we were just entering retirement? At first blink, that sounds nice. But when talking about retirement planning, which hopefully would last at least 20 years if not more, it just’s not that much. If you factor in a 4% inflation, in 15 years, that chunk of money would be equivalent to $83,000 plus a latte in today’s dollars. Yikes! That kind of sinks the party.

Next, let’s think about the magic of compound interest. Everyone likes to mention that in financial articles, because it’s the most powerful tool every invented! Whether or not Einstein actually referred to compound interest as the most powerful force every created, financial advisors like to make you comfortable in your progress to retirement by making it sound as if it will always be there to catch you up at the right time.

In the article I saw they said that “you’ll benefit from time and the power of compounding to significantly grow your retirement savings.” That is a killer soundbite. Except your performance according the financial laws of compound interest can swing wildly either in your favor or against your favor.

If you restrict yourself to only investing in mutual funds and index funds, then you’ll have to be happy with averaging around 4% in annualized growth according to the Dalbar report, which won’t cut it. I took the liberty of punching the numbers up above into my spreadsheet, multiplying the total cash saved each year by a fluctuating growth rate of mostly positive growth with only one loss in that entire 15 year stretch. Considering we have historically suffered a market correction about every ten years, this should prove somewhat conservative.

You know what I got? A total cash value of $210,000. That may sound better, but it’s not a huge return after investing $150,000. In fact, that it’s only a measly 2.2% annualized growth rate!

Click on the image to zoom

You could potentially do better than the mutual funds if you invested that money into some dividend kings and reached retirement with a nice 4% yield in stocks. But don’t fool yourself into thinking this is all you need to do to retire. That kind of yield would only produce $8400 annually, averaging $700/month.

I don’t think $700/month, or $388/month in today’s dollars, counts for “significant” in retirement savings as that article implies. When these articles wave the magic wand of “compound interest” and “dollar cost averaging,” watch out. They are attempting to cast a spell on you to make you think this can grow HUGE.

Dividend kings may help you grow the net worth of your equities better than mutual funds, but make no mistake. Limiting yourself to setting aside $6500 in an IRA just won’t cut it. For example, if life interrupts and causes you to miss any of these contributions, your end results will only diminish. This is the best, and it doesn’t and consider what happens during the worse, such as a market correction the year before you retire or two corrections in the same span of time.

If you already have something else that will provide your main source of income in retirement, then I wouldn’t object to having this IRA to use as fun money. But consider this: is your other source of retirement an order of magnitude bigger in the amount of money being saved, or is it similar to this? If it’s relatively the same in total dollars saved every year, the best you can is double the outcome. Is that really going to be enough?

By all means, I encourage you to create your own version of the spreadsheet up above. Don’t like the rates I picked? Punch in your own percent growths. Try the last 15 years in average S&P 500 performance and see what you get. You may find that things don’t quite work out as well as you heard about in articles and on the radio. And feel free to contact me if you have any questions.

Investing based on fees is the wrong approach

In an article published on Fidelity’s website, there is a detailed description of the new regulations written by the Department of Labor back in February. 401K custodians are going to start including much more information about fees in up-and-coming statements mailed to clients.

More of the shocking statistics that I have mentioned before are published in this article:

  • A poll showed that 71% of 401K participants don’t think they pay any fees
  • Less than 5% of employees using workplace investment plans make a concerted effort to manage their 401K plans.
More info, more profit, right?

Reading the rest of article shows a clear focus on fees. It celebrates that these new regulations will bring fees to the forefront, because active investors may realize the costs of their choices and shift to alternative funds with lower costs. But it hesitates on the subject of passive investors, since they aren’t sure about them. (I think I know how people that don’t read statements will react to more unread information.)

The article fairly indicates that of course there is no such thing as a free lunch. Fees are par for the course. But the whole thing seems be a fallacy, because it implies that mutual funds in a 401K are the way to go. The name of the game is simply picking the best returns and with the lowest fees. We just don’t have enough information to make the right choices. A little more information, and our portfolios will do better.

Crosschecking with reality

Does that sound likely to you? It doesn’t to me, and here’s why: they don’t take into consideration systemic risk. What will happen when all the funds dip with the next big market correction? As usual, people will panic and sell their positions. Then when markets rally, they will buy what’s hot. That will lock in the historical sell-low/buy-high, rinse & repeat pattern of most investors. There is strong historical data showing this to be the case in the past, so we have no reason to doubt it won’t happen in the future. You don’t have to wait for the next installment of the Dalbar Report to reiterate what we already know.
If you are picking funds based on fees, you are just following the herd, but trying to pick a fund that isn’t QUITE as bad as the others. I recently read a chapter from a book where the person argued that if you choose index funds, you only pay 0.2% while everyone else is paying 2% average fund fees, giving you a 1.8% advantage. The author crowed over this, touting it as so simple, kids can understand it. I don’t think building your retirement wealth on 1.8% arbitrage is the answer. That is fear-based and kind of like trying to outrun the person next to you as you flee from an alligator.
Of course, this all tracks right into John Bogle and his strategy that lower cost funds tend to outperform other funds. Bogle developed the idea that indexed funds are more effective overall than actively managed funds. That statement may be 100% correct, but it isn’t enough advantage to build retirement wealth.

Indeed, it may allow you to save up TWICE THE AMOUNT that an actively managed fund can after years of saving, but it doesn’t answer the right question: Will this strategy be enough to truly retire and not end up working at Walmart?

Planning with the end in mind

Don’t forget that a wealth building plan needs to be able to handle life’s rocky bumps in the road that will definitely happen. We will hit various things that will force us to scale back or stop saving money at certain times. The plan also needs to factor in things like systemic risk, our desire to sell when things go bad, taxes, and inflation. I can definitely tell you at 1.8% isn’t going to count for much even if you only consider taxes and inflation. Throw in other risks, and it only gets worse.

If there is another strategy that will build enough retirement wealth despite the hard knocks we may face, then what difference does it make what the fees are? The end result is what we need to be looking into, not the costs along the way.

New study shows excessive 401(k) fees

A new study has come out titled “The Retirement Savings Drain: The Hidden & Excessive Costs Of 401(K)S” by Robert Hiltonsmith. The results are quite shocking. Or perhaps they SHOULD be shocking. I’ve already heard about this, and so I’m not surprised. But perhaps you haven’t? Some of the big ones:

  • 65% of 401(k) account holders aren’t even aware they are paying fees
  • 5 out of every 6 investors lack basic knowledge about the fees everyone with a 401(k) pays
  • fees are taken off the top, meaning reported rates-of-return are post-fee, hiding these costs
  • administering average pension funds costs 46% less than the cost of 401(k) plans
  • new regulatory tweaks that are coming, requiring better disclosure of fees, will have little effect on reducing the fees nor fix the issues associated with market risk and longevity risk
  • the individualized nature of the 401(k) doesn’t work and must be replaced with something else
Did you catch that last one? The author of the study has concluded that much of the issues that arise in 401(k)s is because of it’s individualized nature, and that tweaks and adjustments won’t fix it. The author figures that the new disclosure rules won’t fix 401(k)s, but instead expose them for the bad investment vehicle that they are.
I said shocking right? Well, I already learned this about six months ago. I have been working on my plan to leave my 401(k) behind. I have already stopped putting money into my corporate 401(k) and rerouted that money into an EIUL. In that article, you will find mention of the high fees embedded in 401(k)s. Combine that with the onerous rules that restrict your access to the money, and that pretty much sums up my disgust with them.

The study estimates that people will lose something like $155,000 on average over their working lives to excessive fees, enough to buy a house. What could you do with $155,000 of investment capital? Buy Berkshire Hathaway, or perhaps leverage it with investment property? Both of those options has a higher historical rate-of-return. Why don’t you hear about this from your financial advisor? Aren’t they supposed to be putting you first, according to the license they hold?

Towards the end of the study is a list of bullet points for what appears to be core principles in some sort of universal retirement plan. I think either the author or the institute that funded him believe we should all receive a universal, i.e. government orchestrated pension fund. I have my doubts on how effectively the government can manage something like that, considering their track record with managing social security. I could never support something like that unless we had the freedom to opt out and choose our own path. Or, they may be saying we need something better than what the IRC affords us from section 401(k), and these are the key points that must be met to have a true success. I just don’t remember the government having a big rate of success when it comes to money.
So what is the solution to all this? Don’t be a passive investor. Take active management of your plan. And HAVE a plan. Don’t just throw money at your 401(k), pick a handful of their funds, and then assume it will all work out. At the Wealth Building Society we focus on learning how to read this information, how to understand risk, and how to understand the mechanics of investing, so you can formulate your plan. One of the top reasons so many people are failing at retirement planning is because we have been told it’s easy and we don’t need to really be active. And also that there are plenty of experts out there to handle it for us.

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Tell tale facts about mutual funds

Are you invested in mutual funds? The likely answer is yes. That’s because Wall Street has very successfully pitched mutual funds inside 401K wrappers as the primary means of retirement savings for at least 30 years. This is despite some astonishing information about mutual fund providers.

Did you know that there is over $12 trillion invested in mutual funds? That doesn’t indicate the success or failure of mutual funds, only the magnitude of the situation at hand. After all, there is a lot of money invested in cash value life insurance. Many top executives at large companies provide over funded life insurance policies to their executives as part of their compensation package. At the same time, some of the companies have their salespeople preaching “buy term and invest the difference.”

The average salary for a mutual fund manager is $240,000/year. I have no quarrel with someone making a good salary, since I applaud successful entrepreneurs being rewarded for their efforts and choices. But where this really starts to lose ground is the fact that 15% of these directors stay in the business for 20 years or more. They come back, year after year, and keep managing funds, whether or not they did well. You see, their measurement on how well they do isn’t 100% based on how well you or I do. A significant factor is whether or not they made good sales. Did they keep enough clients from the previous year, or in turn, gather enough new clients. Either way, if the fund itself takes a nose dive, it shouldn’t be an assumption that the fund manager gets fired. If that were true, the turnover would be huge.

61% of mutual funds have lagged the S&P 500 over the past five years. This is where Wall Street’s message of “find a financial investor” gets spelled out crystal clear. In one breath they say, “odds are against you picking a mutual fund that will succeed. You need an advisor.” And then the next thing they say is, “but we can pick a good mutual fund. The odds are NOT against us.” The odds cut both ways. If you are looking at hiring a financial advisor, ask for a listing of every client he or she has had for the past 10 years, and their overall performance.

Let me say that again: ask for their client’s performance. If your potential advisor tries to tell you the 10-year performance of the funds he or she suggested, don’t accept it. You aren’t evaluating whether the fund works. You are evaluating whether his clients succeeded using him.

Another tragic fact of mutual fund companies is that most of the oversight controls are in house. They may have a separate board in charge of oversight that doesn’t directly pick the funds, but this is still under one roof. Now we may look at people like Warren Buffett and Berkshire Hathaway and try to ask, “what is the difference?” After all, Warren Buffet and his board essentially decide what to buy and sell. They own either in part or entirety, over 70 companies.

What’s the difference? A huge one. Berkshire Hathaway has annual shareholder meetings and have votes. Shareholders can vote out board members, even Warren Buffett himself, if they aren’t doing their due diligence. Past members of the board have left due to various differences. This bodes for true accountability to the shareholder. Mutual funds don’t have shareholder meetings. There are not votes. The board put in place makes all the decisions, and the company board overseeing them don’t answer to you either. They are on the hook to answer to the SEC, but when is the last time that the SEC prevented a major fiscal disaster?

Another major difference between mutual funds and owning the same equity in Berkshire Hathaway is what happens when people want to dump their holdings. When you own a mutual fund, you don’t really own stock. Instead you own shares in a fish bowl of equity. When you ask for your piece, they must empty out the fish bowl. Due to their strategy of investing, they may be forced to sell lots of stuff, good and bad, to pay you out. When a lot of people dump their holdings due to a downturn, they have to cash out a lot and take bad losses. It is hard for them to simply sell the most profitable stuff and allow you to share in the good fortune. That’s because a huge portion of the equity of a mutual fund is kept in stocks and bonds (or whatever else they are investing in). Very little is kept in liquid cash.

When you sell a chunk of Berkshire Hathaway, you aren’t asking Warren Buffett to unload any stock. Instead, you are asking another investor to buy your shares at whatever the current trading price is. There is no middle man in this respect the way there is in a mutual fund. Maybe they picked up some bad stocks, maybe their good, but your panicky nature during a downturn doesn’t directly force Warren Buffett to unload good stocks just to meet your liquid needs.

Does any of this sound like the stuff you heard the last time you chatted with a professional mutual fund advisor? I didn’t think so.

To sum things up, mutual funds have been very profitable for the companies. That is probably why the managers can keep their jobs. It should be a tell tale sign that when mutual fund companies keep the same people for decades, their lack of ability to police costs and serve your needs not of serious concern. Actively investing in your own strategies and seeking out products that meet your wealth building needs requires constant, active research on your end. Handing this off to someone tilted towards merely finding the “best” mutual fund for you won’t cut it.

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Does your 401k company match have a dollar limit?

An interesting thing has happened today: my company sent out an update on it’s 401k policy. They have increased the dollar amount of the match they are willing to make. If you read the first part of portfolio rebalancing, you are aware that I’m no longer investing any money there. Since I made that choice, I see such enticements through a different lens. I appreciate the generosity my company has extended, but it’s important to realize companies aren’t successful because they are benevolent and generous. It is more likely a need to stay competitive with other companies and what they are offering. There are probably tax benefits as well to consider from their perspective. There is nothing sinister or wrong about this. It is simply business, and all active financial planning done on your part requires that you think like a businessman.

Did I mention active investing? When I joined my current company, I took a passive approach. I picked a handful of mutual funds from a list, and spread my contribution among them. There was no in depth analysis. Frankly, I didn’t think I needed anymore. Instead, I assumed (as I had in the past) that the mutual find manager would fo his jon and earn me s good retirement. I didn’t realize how passive and wrong I was at the time. Another dimension of passive investing was the fact that I wasn’t aware of the limit of the company match. While they will match a certain percentage, there is a hard limit in dollars of how much total match. Guess what? I exceeded the limit. Even with this new increase, I still can’t get the full percentage match. This all makes for a very manageable situation for my company. They can go to the shareholders and give a very concrete listing of the maximum liability they have in 401k funding.

This is very different than the old style of managing pensions. Instead of managing the complex and unpredictable risk of a pension fund, they can simply add up the number of employees and multiply it by the dollar limit for each year. The rest is, as they say, up to us. If you assume your 401k along with a passive investing strategy will carry you to a comfortable retirement, you’re in for a shock. I have been saving money in my 401k for 15 years. When I started back then, I maxed out to the tune of 15%. At one point they raised the limit, and I pushed it up to 18% (the IRS dollar limit). I did that for years. Then one day, I looked at what was there and realized what was there wasn’t growing fast enough to beat inflation AND fund a comfortable retirement for 20+ years. This is what allowed me to break away from the propaganda of Wall Street and it’s message of the stock market always rising.

I was listening to Dave Ramsey today while driving, and for the nth time heard bim throwing out the same “grow your mutual funds at 12%, withdraw at 8%” gibberish. Mutual funds average 7% with wide swings. In fact going back to 1951, the S&P 500 has swung from between 5.15% and 10.05% over any given 30-year period. Mutual funds  tend to underperform this index, so expecting 12% is ridiculous on its head.

Advisors have been telling people to withdraw no more than 4%. Factor in that this must be based on the roller coast value of your portfolio and NOT on some average (to avoid dipping into the principal), and you must realize your mutual funds are just too risky with their horrendous track record to be your primary venue of retirement. I don’t have anything against my company. It’s just important to understand that what is best for you, your company, and the IRS do not often coincide.

Cross posted from

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Go anywhere funds that really go nowhere

I chuckled as I saw an article today posted on titled “5 funds that ‘go anywhere’ for a smoother return.” It involves a new “type” of mutual fund. They are called ‘go anywhere’ funds, meaning the fund manager isn’t constrained to the usual set of restrictions, like only investing in certain types of asset classes, or adhering to a certain proportion of stocks vs. bonds. Some of the quotes are really quite telling.

“The so-called Lost Decade proved that we don’t need to rely on large equity allocations to seek meaningful returns,” says Rob Arnott, chairman and founder of Research Affiliates and manager of the PIMCO All Asset fund (PASDX), noting many investments, including high-yield bonds, emerging market debt and commodities, offer equity-like returns. Yet, because of the complexities of these assets, there’s value in having an expert calling the shots on when to move in and out of these alternatives.

Is it just me, or is this manager now telling us that asset allocation doesn’t work? Not wanting to put words in his mouth, let’s see what another manager quoted in that article says:

Because the funds potentially can go anywhere, they may throw a wrench in your overall asset allocation but “that’s not always the worst thing,” says Waddell, explaining there are times when it pays to have a good manager making big-picture calls on your behalf. Still, it’s not a bad idea to see how such a fund will mesh with your other holdings by taking a look at the manager’s track record and current holdings.

It seems both Arnott and Waddell are telling us that it wouldn’t be the worst thing if the fund manager was able to go out and simply pick what is best and had the best deal. From 10,000 feet, it sounds like the same approach taken by Warren Buffet. He seeks out companies that are different sectors, ranging from insurance to jewelry stores, to shoe makers, to brick manufacturers, to carpet makers (and that ain’t the half of it!) But people none-the-less keep throwing stones at Warren Buffet even though he consistently beats the S&P 500.

Looking towards the bottom of the article, I notice a matrix showing the performance of five such funds. Strangely, they didn’t list all the ones actually mentioned in the article. I guess it is only the “go anywhere” funds that are sold by Fidelity. Though they mentioned 10-year returns in the article, I only see 1, 3, and 5-year annualized returns in this matrix. Why is that? Is the 10-year performance not too hot? Well the best one only sports an 8.23% 5-year return. With a 0.76% expense ratio, it would appear that my total gain (before taxes) would be 7.47%! Subtract 30% in taxes (5.23%) followed by by 4% inflation, and all you get is 1.23% gain. Not too good for long term wealth building in my opinion! Not to rub salt into your wound, but the article touts that these funds are doing better than 85-95% of the other mutual funds. Yikes!

And why are they coming up with these new strategies? Because the other ones crashed and burned over the last decade! People jump ship when mutual funds nose dive, so the Wall Street salesforce needs to offer something “new and exciting” that people are willing to buy, causing a reaffirmation of our human nature to sell to stop losses, i.e. sell low, and then buy on the upswing, hitting the high point, and killing our overal wealth building performance.

Bottom line: if 1.23% gain is what I have to look forward to, then you can count me out of trying use mutual funds to build my retirement wealth. But let’s at least adhere to the tail end of the second quote: “it’s not a bad idea to see how such a fund will mesh with your holdings by taking a look at the manager’s track record and current holdings.” Indeed, let’s check what the managers track record looks like over a 20 year period. Because that is the traditional time window we really have.

Cross posted from

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Your 401k won’t create wealth

If you are paying income tax on your cash flow that is too high in your opinion, then there are many strategies that could lighten that road not using an 401K investment strategy. The real issue is would you rather pay taxes on input or output? So you input $100,000 and have a $250,000 output. Which would you rather pay taxes on? Personally, I have learned there are many options to deal with the tax issue on my income/cash flow. But when you are retired and are FORCED to take cash flow from your 401K and incur income tax there are much fewer options. The popular one for most financial planners is to be so poor as to not have to pay a high income tax rate. There are some real reasons why I think most 401K plans are a fools paradise (low rate of returns, loss of control, penalties for access, more net tax obligations, etc.) but for most folks who are employees I think the biggest one is the con job Wall Street has done convincing them that this retirement strategy can become one’s primary retirement income. Nothing wrong with funding a 401K if your company is matching you up to the match, but if that is all you got you are in trouble. That is why I show people how to build real wealth in other vehicles and then suggest they have a EIUL to protect them from premature death and the tax man. I think that the 401K/EIUL comparision is a straw man argument because both are poor wealth creators. Better put that $15K/year into investment real estate and have some real time tax protection, build wealth, and then protect it with a EIUL. You see it is the plan that is important and how each strategy fits into the plan. I just don’t think buying mutual funds is much of a wealth building plan whether you get a tax break from it or not. You don’t think that the government designed the 401K to decrease tax revenue do you? –David Shafer, 

 That comment is one big nugget of wisdom when it comes to investing for the future.

You especially can’t escape the simplicity of David’s closing sentence, “You don’t think the government designed the 401k to decrease tax revenue do you?” We BOTH know the answer to that!

Cross posted from

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Scala makes it easy to evaluate financial problems

Over the past couple of years, I have been innately fascinated by the emergence of scala. Discovering it’s incredible power of type inference, a very extensive collections API, pattern matching, and many other things have been very alluring.

Recently, I had a question pop into my head regarding financial data. You see, I often hear people cite things like “the average performance of the S&P 500 is 12%”. What? That is crazy. I know that isn’t true, and betting your retirement on it is not good. Where does this come from? I saw a short video clip where two financial advisor explained that many people use the arithmetic mean instead of the geometric mean to calculate this value. But I’m getting ahead of myself.

I went and tracked down a website that listed the performance of the S&P 500 back to 1951. I grabbed the numbers from 2001-2010, and punched them into a spreadsheet. Using SUM, I was easily able to calculate the arithmetic mean. Then I tried to calculate the geometric mean. This meant taking all those percents and multiplying them together. Guess what? Neither LibreOffice nor Google Docs spreadsheet have a MULTIPLY nor a PRODUCT function. Well, at least one that handles a list instead of two values. As my mind wandered away from spreadsheets and into software solutions, I realized this was the perfect thing to write a tiny scala app with!

First, we need to create a simple app. We do this by extending scala’s App trait (NOT the dated Application trait).

Next, let’s load up the data using scala’s List function. In this case, we are storing a tuple using () notation, containing the year and the relative change.

Next, we can write a foldLeft to start with 0.0, and then add each entry’s second item using the ._2 method. At the tail end of our foldLeft, we divide it by the size of the sequence.

See how easy this function was to write? We can tabulate everything, or just a slice but the simplicity of this function shows why many people use it to write simple financial advice. But that’s not enough. For a more accurate evaluation, we need to figure out the geometric mean.

First, we need to convert one of these relative percents into an absolute multiplier. Since I like to read outputs in relative percent format, we will need another function to convert back.

What could be a single function, I decided to break out into two. It’s nice to know total growth as well as average growth per year (also called annualized growth). Given that function, we just need to take the nth root based on the length of the list.

With these functions, it is easy to run our entire list of historical data and find the average growth of the stock market. But that isn’t all I wanted to know. I really wanted to see what would happen if my money was invested in an EIUL, meaning that in negative years, growth would be capped at 0.0%, and during booms, growth would be capped at 15%.
I wrote one solution, but it was clunky. I got some help on stackoverflow, and instead coded a way to basically sort each year’s performance against List(0.0, 15.0), and pick the one in the middle. For negative years, 0.0 is in the middle. For big booms, 15.0 is in the middle. For everything else, the stock market number itself is in the middle.

A cornerstone of functional programming is working with lists of data, and transforming them based on your needs. In this case, we need a function that applies the conversion function above to an list of stock data. We can do this easily with scala’s map function.

So, now I can evaluate the entire performance of my money if it was invested in some 500 index fund and compare it with the growth potential of putting that in an EIUL. And it was pretty simple! Imagine what this would have taken to write in Java. It would be clunky, hard to decipher, and probably littered with many more bugs.

I have heard it said that scala makes hard stuff easy and impossible stuff reachable. So I pushed myself. I remember speaking with one of my financial advisors (I have several to provide multiple sources of input to my plans) and he was talking about the average rolling performance of 15 year windows over the past 30 years. Could I write a little more code, and do that myself? I think you know the answer. Start at the first entry of the list, grab n items, then step to the next one and do the same. Before I could write this myself, I checked scala’s collections API only to find a sliding method call to already do this for me.

To have this analysis carry some statistical weight, let’s write a function to calculate standard deviation.

Given all this, it’s time to crank out some output code. Let’s analyze the performance of the S&P 500 and our EIUL, comparing all 10-year, 15-year, 20-year, 25-year, and 30-year intervals.

Let’s wrap it up with a closing brace.

Let’s run it!

This shows that EIULs should pretty consistently beat any index fund based on the S&P 500. It’s possible, due to the variance, that the S&P 500 can beat an EIUL. But the standard deviation of the EIULs are much slimmer showing you a more consistent expected return on investment. S&P 500 has much wider variability meaning you can strike a much better rate, or be passed up my inflation.

And what’s more important: neither of these solutions will make you rich. To do that, you need to be consistently hitting double digit returns. The only type of investment vehicle that has evidence of doing that is either real estate or something with higher risk, such as running your own business. Funds and EIULs aren’t made to make you rich. EIULs, however, are great ways to store money you make through your investment endeavors and later pay a back to you in a consistent, predictable, and TAX FREE manner.

UPDATE (5/18/2012): Since my blog entry was cross posted at Uncommon Financial Wisdom, I have updated the scala app to also find the minimums and maximums for each window. See for the code updates as well as the results displayed in the README file. Visit David Shafer’s blog and give him a call if you want to talk to a real wealth building expert.

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Rebalancing my portfolio – Part 1

I’ve recently started a plan to rebalance my portfolio. The first leg is to stop investing in my 401k, and instead route that money into an overfunded Equity Indexed Life Insurance policy (EIUL). More on exactly what that is in a moment.

Mutual funds won’t earn you 12%

Over the past six months, I have done a LOT of reading and analysis. Did you know that over the past 20 years, investors have averaged no more than 4% return on investment when using mutual funds? Google for Dalbar report and see for yourself. To top it off, that doesn’t count taxes and inflation. Watch the video linked in here to see an example of a 401k that charges a whopping 3.6% in fees without the corporate 401k trustee even being aware of it. This is pretty bad, considering the person who originally crafted the ideas of 401k states that 1% fees should handles costs as well as provide a reasonable profit margin. With fees that high exacting year-after-year, you could lose anywhere from 40-60% of your earnings by the time you reach retirement. To add insult to injury, the trustee managing your corporate plan may only be relaying what the 401k provider is telling him, and not seriously looking after your needs. This is why only YOU can be in charge of your money, and it really is YOUR responsibility to understand everything about your retirement plans.

Tax deferred is planning to fail

Are you saving money in a 401k plan tax deferred? Did it sound good to not pay taxes today and let more of your money grow before cashing in when you retire. Guess what. When you defer taxes for 30 years it can take as little as 5 years in retirement to spend all those tax savings. And don’t expect to receive a thank-you letter from Uncle Sam. They designed it that way, so consider that works-as-designed. The truth is, it is usually better to pay taxes now and retire as tax free as possible. This takes out the risk of tax increases or bigger income as you approach retirement. If you are planning to retire in poverty and with lower taxes in the future (a big gamble), then tax deferred savings may be fine. But I prefer to call that planning to fail.

Losses will cost you more than the gains

There is something people don’t realize, and most financial advisors don’t seem to mention: losses will cost you more than your gains. For example, what if you had $100,000 in your mutual fund and had the following returns: -50% the first year, followed by three years of 20% gains. What would your average annual return be? -50% + 20% + 20% + 20% / 4 = 2.5%. So…you should have $102,500 after your years, right? Wrong. Let’s walk through this year-by-year, and find out what our REAL gain would be.

  1. After taking a big hit in the first year, your account will be worth only $50,000. That’s pretty bad.
  2. But what will a 20% gain get us the next year? Only $10,000 more, bringing us to $60,000.
  3. The third year will pull us up to $72,000.
  4. And finally at the end of the fourth year, we end up at $86,400.

So with a nice 2.5% average growth, we actually lost a total of 13.6%! That’s because when you lose money, it takes a lot more to gain it back. Let me say this again:

When you LOSE, it takes MORE to get back to where you started.

10% loss requires 11% gain, 20% loss requires 25% gain, and 50% loss requires 100% gain. Do you really expect to have three years of 20% gains like we saw up above? Has this type of gain happened for you yet? I think not. This is the sort of thing, combined with people on TV and the radio promising 12% returns as the norm, that causes a huge majority of investors to chase after the hottest funds, and in turn losing a lot more than they realize.

Tax free and no losses is worth more than you know

The key thing we seek is something that will provide you

  • tax free income
  • no losses during the negative years

Well, when it comes to tax free, the first thing you are probably thinking of is a Roth IRAs. That is because Wall Street has been marketing this stuff HEAVILY! Roth IRAs only let you save up to $5000 a year, and only if you don’t make too much money. After a certain point, you have made too much money and you can’t save a nickel that way. Throw in the fact that you can only withdraw the money after a certain age, and these are basically off the table as an effective savings tool.

Some companies have started offering Roth 401ks. They invest after tax money, but neither of the two companies I have worked for offered them until very recently, meaning there is little to put in there. But 401ks are still subject to the high fees, so I just wouldn’t go there.

(There are very particular cases where I would use a Roth IRA, but for today’s discussion, I don’t see them as a central place to save money for retirement.)

In the previous section, we discussed the importance of avoiding losses more than finding gains. What would our scenario have looked like if we could just skip the negatives? What if I found you a fund that instead of losing money in a negative year, we just took 0%? Let’s call it our “special piggy bank fund”. For giggles, we’ll even take take it on the chin and accept no more than 15% gain if the markets rise more than that. What do you think that will look like?

  1. In the first year, the stock market drops 50%, but our “piggy bank fund” doesn’t change, effectively growing/losing 0%. That means we still have our $100,000.
  2. For the second year, the market rises 20%, but we are limited to just 15% growth. This leaves us with $115,000.
  3. In the third year, the market rises another 20%, but again we only get 15%. This will move us up to $132,250.
  4. After the last year of our scenario, the market rises 20%, but we only net 15%. This leaves us with $152,087.50.
So, by taking no losses and only getting a maximum of 15%, we ended up with a little over $152,000, or a 52% increase in value. Compare that to the $86,000 we ended up with earlier. Which plan would you choose?
Looking high and low for a no tax, no loss fund
Just where can you find this type of investment? No losses? That is something your advisor is more likely to laugh at than give you a real. answer.

It turns out that our “piggy bank fund” is an overfunded cash value life insurance policy. By “overfunded,” I mean putting as much money in as IRS rules permit based on the policy’s face value. By “life insurance policy,” I mean an equity indexed universal life insurance policy that doesn’t actually put money in the stock market or buy index funds that have the risk of negative years, but instead sells index-based options. This means that in negative years, no one buys the options, and your money stays where it is, effectively a 0% growth. But in positive years, they sell options to grow at 15%, and when the growth is 20%, people buy the options to make profit through arbitrage, helping us along the way.

Is this overfunding too good to be true? Well, yes and no. The reason to overfund is to minimize the cost. Insurance companies make money on the premiums based on the face value of the policy. A $10,000 policy is much cheaper than a $300,000 one. But you can’t buy a $10,000 life insurance policy and then stuff $10 million into it. Before the 1980s, that is essentially what the rich were doing, and the IRS stepped in and put an end to that. The premiums and profits reaped by the insurance companies on such a small life insurance policy were almost non-existent, while the tax savings and guaranteed growth rates were huge and TAX FREE. The IRS doesn’t like tax free, so they put limits in place. But if you fund up to these limits you can still do quite nice. In my book, if the IRS doesn’t like it, then I DO!
“But this is life insurance! You only reap the rewards when you die!” I know this is what people usually think of with regards to insurance, but it’s incomplete. You are allowed take out loans against your policy. When you eventually die, the balance of your loans is deducted from the face value of the policy, leaving you with whatever you didn’t spend. And here is the ka-ching: the loans are considered TAX FREE money, and you actually DON’T have to pay them back!

“You should never mix life insurance and investments.” This sounds like a catch phrase with no basis in real facts. Go dig in deep and found out the differences between overfunded insurance and plain, simpleton insurance. There is a big difference. A big, tax free, no loss difference. Given all these facts, I say it’s just fine to mix the two together, because that is how this type of insurance was designed in the first place!

The bottom line
Imagine putting $500/month into an EIUL with no losses, EVER! As another factor, let’s increase our monthly savings by 4% each year to symbolize pay raises and increased cost of living. After 25 years, this would add up to around $250,000 of outlaid money, but could conservatively (8% average per year) accumulate over $1 million in savings. Now, instead of putting any more money away, you start taking out annual tax free loans. If we estimate withdrawing for the next 20 years, we may be able to get about $80,000/year. Added up, that would yield $1.6 million in tax free withdrawals.  Now go and visit your 401k and tell me what it’s going to take to save enough to withdraw $80,000/year TAX FREE. Do you remember your financial advisor mentioning never taking out more than 4% each year? To get $80,000, you would need $2 million. To handle a simple 25% income tax, it would be more like  2.6 million.
Not. Going. To. Happen.
So when I hear Dave Ramsey or Suze Orman move beyond helping people get out of the black hole of consumer debt, and start bad mouthing whole life insurance, saying to never mix investments and life insurance I just smile and instead take the advice of rich people in past generations. Most life insurance agents don’t know how to set up overfunded life insurance the proper way. Instead they seek to line their own pockets with profits, which has probably produced this backlash and  the “buy term and invest the difference” mantra. This is where YOU must lookout for YOU. An agent willing to set up an overfunded policy as mentioned above usually takes a 50-75% cut in total commissions. This makes such agents hard to find, but they are out there if you know where to look. Contact me if you want to know more.
To wrap up this first stage of Rebalancing my portfolio, I can sincerely say I’m putting my money where my mouth is. This is not a case of “tis for thee but not for me.” It is a cornerstone of my overall trajectory in saving money for retirement, but not the only part. Call me up in 20 years, and we’ll see how our financial plans are doing. I sure hope I don’t meet you as a door greeter at Walmart while my family is vacationing in Florida, seeking extra pay to make up for a lack of accumulated value and infinite trust in someone else to take responsibility for your retirement.Cross posted from

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.