Every investor should have one ultimate goal at the end of the day: to end up with the highest possible net spendable income. As simple as that statement may sound, most financial professionals totally miss this crucial goal, sadly confusing it with earning the most possible money from any given investment. You can see this theory at work in all of those colorful investment sales brochures, which seem to erroneously suggest that how much an investment grows is more important than how much an investor actually gets to spend.
Let’s illustrate this with a simple example.
Say we are comparing two investments: A, with potential return of 10 percent and B, with an 8 percent potential return. We expect most advisors to discount these rates with the costs of the investments – which we’d assume to be 1.5% for A and 1% for B. Therefore, investments A and B would net – after cost – 8.5 percent and 7 percent respectively. At this point, the majority of financial professionals would simply settle for investment A over B, because A will generate the most money, REALLY? But is that always the savvy thing to do? We believe it is not necessarily so.
Tax Efficiency, Tax Efficiency, Tax Efficiency
We teach our investors that ultimately, it does not matter how large a balance your portfolio accumulates, but rather how much, as an investor, you actually get to spend. So you want to pay less attention to how much an investment earns, as opposed to how tax-efficient it is.
Let’s continue with our example. What if investment A were taxable at, say, a 25 percent income tax bracket, but investment B were tax free? In such a scenario, the actual net-spendable-cash-on-cash returns come out to be 6 percent for investment A and 7 percent for B. What a big difference a little diligence makes!
The unfortunate news is that because tax issues generally don’t arise until the withdrawal phase – when it is usually way too late – millions of unsuspecting investors are caught unaware. And as a result, they’ve got a lot less nest egg than they’d been anticipating.
Some attempt to dismiss this critical information that can make a huge difference in planning for a better future as too simplistic, or they toss off the bogus assertion that retirees tend to be in lower tax brackets. Just as we cannot predict any investor`s future tax rates, realize that no financial professional has a crystal ball, either.
That is why we strongly advocate nonqualified tax-free vehicles – you will have nothing to worry about with a zero percent tax rate.
Strategy Also Matters
Let’s look at another example of Strategy X versus Strategy Y. In Strategy X your investments have no caps or floors – you simply make whatever the market makes. Strategy Y, on the other hand caps your gains at 12 percent, with a guaranteed minimum of 2 percent.
If you are like most people, your inclination would be to go with Strategy X, because you perceive caps on gains as a negative thing and believe that, over the long haul, the stock market will deliver. We’ll see if you change your tune once you start to actually do the math.
For the sake of this example, we will try to mimic what tends to happen with the stock market – ups and downs – and assume that in Year 1, the index made a 20 percent gain. Under Strategy X, a $100,000 investment – with all other things equal – would have grown to $120,000, while with the 12 percent cap in Strategy Y, it would have grown to just $112,000.
Now assume the index loses 10 percent the following year. Strategy X would have a balance of $108,000 ($120,000, less 10 percent). Strategy Y, on the other hand, would have a balance of $114,240 (112,000, plus the 2 percent guaranteed minimum). Looking pretty interesting, isn’t it? But wait – let’s look at what happens in Year 3 before drawing any conclusions.
If in Year 3 the index posts a 10 percent gain, the Strategy X investment would grow to $118,800 (10 percent gain on $108,000), while the Strategy Y investment would grow to $125,664 (10 percent gain on $114,240).
How soon, easy, and likely would it be for Strategy X’s balance to catch up and overtake Strategy Y? Of course, no one knows for sure, but we hope the millions of hard-working investors who are seeking a better retirement become a little better informed before making their investment choices. What we do know FOR SURE is that it’s never a smart idea to put your retirement funds or your children’s college money at the direct mercy of an unpredictable stock market – regardless of how much time you may have to build your investment.
Regain control of your future with an absolutely no-obligation consultation by calling (301) 949-4449 or visiting www.LaserFG.com today!