The Hidden Risk of your 401k …

Posted on July 1, 2008 by Adrian

Recently I wrote a post that challenged the ‘Set It And Forget It 401k Brigade’ to at least rethink their strategy instead of just automatically maxing out their 401k …

… in doing so, I mentioned that there was a ‘hidden risk’ in your 401k.

Whilst the 401k proponents put forth all the wonderful, low risk arguments in favor of 401k’s (quoting long-term market averages of 12%+) they conveniently forget:

1. Fees: Figure around 0.5% – 1.5% in fees set by the funds that your 401k invests in and the fees associated with managing the 401k and the underlying funds (but, only the ones that your employer doesn’t pay). Most of these are conveniently hidden in your returns.

2. Market Dips: Did you know that while the ‘market’ averages 12%+returns, you can only count on 8% as your 30 year return, 4% as your 20 year return, and 0% as your 10 year return from the market. My rule of thumb is: when planning your retirement, count on less … enjoy the possible upside when you are wrong!

3. Inflation: It takes time to get to the nest-egg that your 401k will give you … 20 – 40 years when you are starting out … so $1 Million just ain’t all that much money (now, let alone 20 – 40 years time!).

But, that’s not the hidden risk that I was talking about … it’s much, much more dangerous than those …

… the hidden risk of your 401k is that you may not get enough out of it to retire well.

Almost as bad, you may not care enough now to plan for what may happen then; after all, for you ‘retirement’ may be still 10 – 20 – 40 years away! Although, it need not be …

So, what do I mean?

As I said yesterday, the arguments that the 401k proponents put forth center around: it’s ‘forced savings’; it’s pre-tax savings; and, the possibility that you get free money from your employer!

All good things to have in an investment. But, not the only things …

… in fact, there’s only ONE THING that I want from an investment: that it gives me a return that supports My Life.

Not, the life that the investment is capable of supporting … not the life that I have … not even the life that I want … but, nothing less than the life that I need.

Just remember this: there’s nothing holy about a 401k.

The purpose of your 401k investment is NOT to get a tax break, not to put aside 15% of your gross salary a month, and not to get any employer match … they are just (important) features …

Just like any other investment, your 401k’s purpose is to help you get you to Your Number so that you can live Your Dream!

Anything less is just settling for less. So, let’s consider the binary options here:

1. Your 401k will get you to your Number

You know your Number, right? And, you know when you need it?

If not, either read this and do this … or, you’ve just wasted a valuable 3.5 minutes beer drinking, relaxing time that would have had a far more beneficial effect on your life than what you have just read … or, will ever read … on this blog!

And, you know what your 401k can deliver by then, right? Not when your employer says that you retire, but by when you need The Number!

If you haven’t done the calculation yet, ask a Financial Adviser to help you (or follow along with our 7 Millionaires … In Training! at http://7m7y.com starting with this article) …

… you think knowing this might be just a tad important?

Now compare what your 401k is likely to be able to produce (now, I would not be using ‘average returns from the stock market’ for this life-critical calculation … I’d want a buffer … but, that’s really up to you and your bean-counter) with Your Number …

… if they are much the same, stick with your 401k (after all, it is ‘set it and forget it simple’). Then concentrate on keeping your job and, getting bigger and bigger pay-rises, because you’ll need ’em!

2. Your 401k will NOT get you to your Number

If your 401k will not get you to your Number, what choice do you have but to at least consider alternates, be they instead of – or in addition to – your 401k savings plan …

… be they real-estate, stocks, 2nd/3rd/4th jobs, marrying into money, winning the lottery, businesses …

…. be they whatever …?

Of course, you could just give up and settle for your lot in life; who am to tell you not to give up on your dreams?

I’ll leave that little job up to Frankie 😉

That little pup called inflation …

Posted on June 24, 2008 by Adrian

If you’ve been sticking around to see how the 7 Millionaire … In Training! ‘grand experiment’ can pay off your you …

… your patience is about to be rewarded – at least, that is my sincere hope.

Starting today are a series of special weekly posts at http://7m7y.com designed to help you find your Number.

This is perhaps the most important financial exercise that you will ever undertake in your enitre life … at least, it was for me! Whether you intend to be an active participant in my second site or not – this is my gift to you:

All you need to do is read the posts, starting today and continuing (once or twice a week) for the next 3 weeks, and follow along with the simple – but critically important – exercises that I will be providing. Like everything here, this information is provided free, without any catches, for your benefit. Make good use of the opportunity … it won’t come around again.

Good Luck and I hope that it is as profound an exercise for you as it was for me! AJC.

_________________________________________

Sometimes you can’t see further than the back of your own hand until somebody points the way …

… then it just seems so damn obvious that you wonder why all of those other dopes out there are still staring at the backs of their hands!

I was preparing for a radio interview the other day and I happened to pull up an old e-mail (that I mentioned in a previous post) from Fidelity – a fine investment management company – that proudly proclaimed:

Did you know that weekly contributions of $34 could potentially grow to over $76,000 in 20 years?

At the time, I just wrote my little counter-piece and laughed it off because that $76,000 probably won’t even buy you a car in 20 years time!

But in thinking about it – and, this is what I said on air – it’s actually much worse than that …

You go without lunch every day for the next 20 years, and you don’t even get a new car?!

How the hell are you ever going to retire!

Think about it, if $34 a week gets you $76,000 in 20 years … then, you would need to save $340 a week for the next 20 years just to get $760,000 !

Now, even if you could figure a way to save $340 a week (starting right now!) $760,000 a year in 20 years is NOT the same as having $760,000 today …

$760,000 today will get you a reasonably ‘safe’ income of $30,000 a year (indexed for inflation) if you invest the capital wisely, if you don’t suffer any major losses, and if you don’t spend any of it up-front or along the way.

In other words, the equivalent of $30,000 a year has to buy you everything you need and want for the rest of your life!

But …

That’s only if you have the $760,000 today!

If you’re like the rest of the world, to get there you’ll need to put aside that $340 a week for the next 20 years, but that little pup called inflation will be nipping at your heels the whole way …

… and, that $760,000 in 20 years will only be ‘worth’ $350,000 if inflation is just 4%. I can’t even begin to think about what would happen if inflation rises to 5%+, as predicted.

That means that you get to live on $14,000 (in today’s dollars) a year!

So, how much did you expect to save?

By when?

But, wait, Fidelity is offering a 7% annualized return … aren’t you going to invest that money in the stock market (an ultra-low-cost Index Fund, of course) that averages 13% a year?

Sure.

Because the day that YOU invest the market is going to crash, WWIII is going to break out, the sub-prime crisis will just be getting into full swing (again … will they never learn?), or worse.

YOU, my friend, will need to plan for numbers that you can rely on because you only get one shot at this …

… and, the money has to last you for the rest of your life – unless your backup plan is (a) still checking out groceries at the local supermarket when you’re 75, (b) eating dog food, or (c) let me hear it [leave a comment].

And, the number that you can rely on is this: 8%

Because, you can put your money in an ultra-low-cost Index Fund (we’ll forget about minimums and entry/exit fees for now) and rely on the fact that the market has never had a 30 year period where the returns have been less than 8% (that includes periods of war and pestilence and pure market stupidity).

… but, now you have to wait 30 years; because if you only wait 20 years, you can only be sure of getting a 4% annualized return, and that just sucks.

The good news is that if you can wait 30 years so that you can get a ‘guaranteed’ 8% return and you can keep socking that $340 away, week in week out for 30 years, well that’s over $200,000 a year (at a 4% ‘safe’ withdrawal rate)!

Unfortunately, we still have that little pup (a.k.a. inflation) dragging at us via his leash, which means that you can really only comfortably rely on an annual income of $25,000 in today’s dollars.

But …

You will do (much) better if you can start socking away, without fail, $340 a week and indexing that with inflation as well (in 15 years you’ll be putting away $588 a week and in 30 years $1,060 a week).

In fact, if you can maintain that regimen for 30 years, you’ll deserve a medal as well as your annual income of $37,000 in today’s dollars!

$14,000 … $25,000 … or even $37,000 a year in 30 years: is that really what you had in mind?

I suspect not, or you wouldn’t be reading this blog 😉

Age is NO obstacle!

Posted on June 3, 2008 by Adrian

Applications for my 7 Millionaires … In Training! ‘grand experiment’ are now closed. I will be announcing the Final 30 Applicants this Thursday at 8pm CST on my Live Chat Show … if you want to follow along, I will also be announcing the next Millionaire Challenge! This will help me decide the Final 15 … now for today’s post:

It seems that blogging and personal finance is a ‘young man’s game’ …

… not so!

At least, not according to Lee, who was yesterday’s Featured Applicant for my new 7 Millionaires … In Training! ‘experiment’.

You can read Lee’s story on the 7m7y site, but I wanted to share the following with you:

Lee is a ‘tad’ older than me 🙂 and is an e-mailer, emoticon’er, and … a blogger. Go Lee!

Whether Lee joins our program from the front-lines or the side-lines, he will succeed because age is NO impediment.

Here are two related stories:

1. There’s an old ‘urban myth’ that says that a retired ‘colonel’ with no money and no prospects at the age of 70 left for a journey across the USA, living out of his car! All he had was an old family recipe for chicken that he wanted to ‘licence’ to restaurants. 1,000 restaurants and 2 years later, all he had was a trunk-full of “no, thanks!”.

Then restaurant number 1,001 said “yes!” … and, that’s how Colonel Sanders came to launch Kentucky Fried Chicken (now, KFC) … or so the story goes!

His actual story is a little less ‘dramatic’, but I really feel epitomises the path that people like Lee need to (and, can) take: ‘The Colonel’ actually started at the age of 40, cooking chicken dishes for people who stopped at his little gas-station in Kentucky.

At the time (he wasn’t a ‘Colonel’ yet) he did not have a restaurant, so he served customers in his apartment at the gas station!

Eventually, his local popularity grew, and Sanders moved to a motel/restaurant that seated 142 people where he just worked as the cook. Over the next nine years, he perfected his method of cooking chicken. Furthermore, he pioneered the use of a pressure-fryer that allowed the chicken to be cooked much faster than by pan-frying.

He was given the honorary title “Kentucky Colonel” in 1935 by the Kentucky State Governor. Ever the ‘salesman’, Sanders started to call himself “Colonel”, even dressing in the stereotypical “Southern gentleman” outfit that we are now used to seeing; he was the consumate marketer!

After the construction of a major highway bypassing his town reduced the restaurant’s business, Sanders had to leave so he took to franchising Kentucky Fried Chicken restaurants, starting at age 65, using $105.00 from his first Social Security check to fund visits to potential franchisees.

To me, that’s the real story: a 65 year-old fry-cook funding a franchise from Social Security!

2. The second story is a little more personal … highlighting the moment when I can remember being most proud of my own father.

It was my 30th Birthday and my father was at my Surprise Party (I am so thick, I didn’t notice all the cars on the street, the late arrivals hiding behind the trees, or even the balloons when I walked in … boy, was I surprised!) happy as a Dad can be.

The next day he told me that it was on the day of my party that he had been fired from his job – what made it worse was that he had been ‘stabbed in the back’: it was a finance company that he helped start for a ‘friend’, who (once my father had done all the hard work to get the company up and running with a solid book of business) reneg’ed on their deal to pay my father a 33% profit share.

Just two weeks later, at the age of 60, my father had found an ‘angel’ for seed funding and a bank for the major funding and was off and running … a feat that I was (fortunately) able to repeat just a few, short years later (and, unfortunately that I HAD to repeat … but, that’s another story).

Lee, age is NEVER an obstacle …

What does it mean to be wealthy?

Posted on May 28, 2008 by Adrian

7million7years live tomorrow (!) and 7million7years in the press:

Two of my favorite sites are TickerHound (the Investment Q&A Community) and the Tycoon Report (Daily Investing Newsletter); and, they’re both free!

Also, 7million7years got two mentions when these sites got together here 🙂

Now for today’s post …

Trent at the Simple Dollar rekindled this debate by asking “How Much Money Is ‘Walk Away From It All’ Money?”

I’ll let you read Trent’s post yourself, but, what often interests me most are some of the questions and comments left by readers to my posts and those on other blogs.

For example, I am often asked what my definition of wealth is; I can tell you what it ISN’T:

I DON’T like the simple numerical definitions of wealth that researchers and academics like to trot out e.g. $170,000 income per year; or $1,000,000 in assets not including primary residence; or even the often quoted Millionaire Next Door formula:

Multiply your age times your realized pretax annual household income from all sources except inheritances. Divide by ten. This, less any inherited wealth, is what your net worth should be.

To me, these are just meaningless numbers.

Then there are the passive-income-covers-current-income approaches to wealth [AJC: you may recall that Robert Kiyosaki claimed $100k p.a. passive income as = wealth for him in Rich Dad, Poor Dad]; “KC” left this example in her comment to Trent’s post:

I’ve always said “wealthy” people are folks who don’t have to work and can live off their savings, pension, social security check, dividends, and any other non-work related payments. That is an age dependant term. My 90 year old grandmother is wealthy by those standards – but I’d hardly call her style of living wealthy – but she is able to live comfortably off her savings cause her budget is so small – no car, paid for house, minimal food & utility needs.

I disagree with this definition of wealth, because of exactly that scenario: the ‘cash poor’ person who accepts a certain level of lifestyle because that is what they can afford. They have one benefit: they can maintain this lifestyle WITHOUT WORKING therefore some would consider them wealthy. But, to me, they are still just getting by …

… which is interesting, because KC then when on to show the contrast:

My in-laws are wealthy – they both have pensions and health benefits, but retired early (55’ish) due to a sizable inheritance and wisely saving money when they were younger despite knowing they’d come into an inheritance. I would describe their lifestyle as wealthy – European travel, upscale cars, very nice paid-for home.

This lifestyle has all the trappings of wealth … but, to me ‘trappings’ do NOT equal wealth. So, KC what would I consider wealthy?

Simple, it’s the definition that you provided, with an additional – but critical- twist:

It’s having the regular passive income to cover your ideal lifestyle not just your current lifestyle!

Your ideal lifestyle is the one that you measure by what you DO not what you HAVE …

… the DO part is about legacy: what, if anything, do you want to be remembered for?

The financial part of this is then simple. Just ask yourself: how much will it COST (time and/or money) and by WHEN do you need it?

When KC did the numbers she came up with the following:

But for me (a 35 yr old) to be wealthy by the no work standard would easily take 3 million. I arrived at that number by saying what amount times 8% would allow me to maintain my lifestyle on the principal generated? I chose $3 million cause in a few years I’d need that extra money due to inflation. At $3 million I could very easily pay off my home and live VERY comfortably off the 8% interest. That would make me and my husband independently wealthy. Oh well, I’m only about 2.8 million away from my goal – sigh…

Firstly, good on KC for ‘getting’ that you need a hell of a lot more than $3,000,000 AND for figuring inflation into the equation. But, here are some things that she needs to correct:

1. Firstly, she needs to work out her annual passive income requirements – it looks like she’s counting on $3 Million LESS ‘inflation allowance’ LESS Paying off current home.

2. I’m guessing that amounts to something like $150,000 a year that she’s aiming at – a healthy income, but nowhere near ‘reasonably rich’ (that would take about $350,000 – $500,000 a year income: big house, First Class flights, 5 Star Hotels, a couple of fancy cars, private schools). But, let’s assume that she has modest retirement spending requirements: she doesn’t say WHY she needs it, or HOW much … but, we do know that she needs to replace 100% of her time with money as she doesn’t intend to work at all.

3. Before retirement, KC may be able to count on a 12%+ annual compound return (over a 20 – 30 year period) on her ACTIVE investments (forget 401k’s, managed funds, index funds, etc. … to get 12+% she’ll need real-estate and direct investments in stocks), but in retirement, she will want to wind that back to, say 8% on her PASSIVE investments (now she can buy those Index Funds, if she likes).

Why 8%: because that’s the largest return that the stock market has ‘guaranteed’ over any 30 year period, in the last 100 years (the figure drops to just 4% over any 20 year period, and 0% over any 10 year period). And, then we really should deduct mutual fund and middle-man fees …

4. But, to counter for inflation and up/down market swings, KC will need to wind back her withdrawals to somewhere between 2.5% and 5% of her portfolio … 8% is right out of the question! Why? You have to reinvest at least the expected amount of inflation; KC will need a payrise if she wants to keep up with rising prices …

5. That means somewhere between $3 Mill. and $6 Mill. is the ‘Number’ for KC, or she’ll have to be content with taking ‘just’ $75,000 a year in retirement (at least, it will be indexed for inflation) … just remember, if she takes 20 years to get to that $3 Mill. it will be just like retiring on $35,000 a year today. Whilst $75k seems like a lot to most, it ain’t ‘rich’.

Maybe KC was a little optimistic in saying: “At $3 million I could very easily pay off my home and live VERY comfortably off the 8% interest”?

Do you need to shift your financial goalposts a little, as well?

The most dangerous idea in retirement planning that I have ever read!

Posted on May 2, 2008 by Adrian

Double Dose of 7million7years! Please check out my FIRST EVER Guest Post … it’s at BripBlap, a blog that should be on your DAILY READING list: http://www.bripblap.com/2008/guest-post-education-a-curse-or-a-cushion/

In a few weeks, I was planning an ‘expose’ of a book that I read , but just came across a related post by an innovative thinker who calls himself Gryffindor (presumably, named after one of the Hogwarts Houses in Harry Potter) so I can’t resist but to weigh in now …

And, I’m going in boots and all!

First, here is what Gryffindor had to say – which I actually like because it is innovative and a little controversial:

So if an investor has 2 million at the age of 55, what does the conventional wisdom say? He could invest it and with a safe withdrawal rate of 4% count on $80,000 a year. 2 million of savings – with that all you get is a 80k a year. No wonder most people are depressed about retirement.

Now what if the investor takes a million of his nest egg and buys [a] business? She gets $200k of cash flow a year that is growing at 3% to match inflation. She can also reinvest the additional earnings from the other $1 million. She also gets some additional tax benefits of owning the business and can have some productive part-time hobby / business and not just spend her time on the golf course. It sounds all good to me.

And, here is part of my response that I posted on his blog post:

This is such an important topic that I am going to post a response on my blog [which you are now reading!] … I would really like to set up some debate on this because it is a very useful – but, potentially highly dangerous – retirement strategy that really needs to be well thought through before anybody implements.

Rightly or wrongly, some people just see me as a guy who ‘got lucky lucky in business’ (AJC: most of my $7m7y Net Worth actually came from investments … my leter/additional Net Worth came from selling some businesses), so it might seem natural when I say that Gyffindor actually appears to be onto something that is one of the central ideas in a recent book called Get Rich, Stay Rich, Pass It On.

The principle is that rich people keep their money for generations ONLY if they split their assets roughly one-third in a business, one-third in paper (stocks, bonds, mutual funds, etc.) and one-third in real-estate (incl. their own home):

Then, you might be surprised when I say that this is “the most dangerous idea in retirement planning that I have read”!?

What the book is recommending, that I find so damn dangerous for retirees, is this:

The authors of Get Rich, Stay Rich, Pass It On suggest that you need to invest, and keep invested forever, 25% – 35% of your Total Household Assets into ‘continually innovative enterprise/s’:

What we mean here by a continually innovative enterprise is one that either offers a product or service that breaks new ground or changes a traditional product or service so much that it becomes virtually new.

Now, that is something that you do before you retire so that you can retire rich … you take risks, you innovate, then you sit back and reap the profits (or sell) …

… it is not something that you get into in order to preserve wealth, which is exactly what the authors suggest:

At the lowest level of personal involvement, you might invest in a limited partnership, private equity plan, or venture capital program in which the actual management of the enterprise – possibly even the choice of the enterprise to invest in – is beyond your reach and outside your control.

Put simply: this recommendation is crazy …

… in my opinion, it unfortunately totally discredits an otherwise fine book written by authors who are respected consultants who assess the wealth habits of America’s mega-rich for the financial planing industry.

to me it seems that they are confusing the Making Money 201 wealth-building practices that rely partially on risk-taking strategies that may include a business – or, at least look a lot like a business (e.g. rehabbing/flipping real-estate; trading stocks/options etc.) …

… with the Making Money 301 wealth-preserving (i.e. retirement) practices that move you away from risk towards passive income!

So, is there a place for owning a business in a wealth-preservation strategy?

Absolutely!

I think that I speak with some authority on this: I have owned, operated, and successfully sold a number of businesses across a number of countries, many of which I owned at the same time!

I was an active owner in some and am still a passive owner in others …

Now that I am retired before 50, I am giving one part of a business away to my partner, converting another part into a ‘licence annuity’ that I will keep, and I am also keeping one other operating business as a semi-passive entity.

This last one is interesting, as it appears to support the thesis in Gryffindor’s post and the book that I mentioned:

This business is still in another country … it’s a finance company that turns over $40,000,000 per year with a only staff of 4 and nets me a cool $250k per year with about an hour’s work a month from me … I control it (through various legal entities) 100%!

Even so, here is the fundamental truth:

There’s no such thing as a PASSIVE business – as long as you own a business, you:

1. Will lose sleep every so often until it is sold or closes down, and

2. You will NEVER be truly retired.

As long as you can accept this level of semi-retirement worry and activity (which may actually HELP to keep you young!) then the Gyffindor Strategy could work for you, BUT:

i) I could accept owning in retirement: Big Name Franchises; Self-storage facilities; Mobile-home parks; Car-Washes; Your own well-established business that you are now ‘winding back on’.

ii) I would be a lot more concerned about: auto-repair and other skill-based businesses OR ‘vanity businesses’ – you know, the types that celebrities like to own (e.g. restaurants, bars, etc.).

iii) You would need to set out to have the business/es that you select run without you from the very beginning.

If you like the idea of owning a business in ‘retirement’, here’s a hint:

This strategy could hold a lot more attraction for you if you can also own the real-estate that the business operates from!

Why?

A. It assures the rental stream,

B. It assures at least some capital growth,

C. It hedges your bets against business failure (particularly if you plow excess cash generated by the business into the mortgage),

D. It provides a partial exit stream i.e. sell or give the business to management or a buyer under the condition of a long-favorable lease with upward-only ratchet clauses (rents increase at least with inflation).

A final thought:

I mentioned that I will continue to own at least one business now that I am fully retired:

– I founded this business and have owned it since 1991 … it has successfully run without my direct involvement for more than 5 years.

– I tried to sell it anyway, but it was only worth 3 times annual Net Profit before Tax … for that I will keep it for three years and take my chances!

– If I do happen to find a buyer who will pay me 5 or 6 times annual Net Profit before Tax, I will sell it.

– I do not count this business’s income towards my retirement portfolio’s ‘safe withdrawal rate’ because anything can happen with a business at any time … rather, I use the profit to build my portfolio’s total value, and spend the passive income from that.

If I do eventually sell it, THEN I will increase my portfolio’s withdrawal rate because I will have converted the business into a passive investment (cash, stocks, or real-estate).

Phew! This is one of my longest posts … so, now it’s your turn to comment!

How do I figure social security and pension plans into my 'Number'?

Posted on April 14, 2008 by Adrian

In a couple of posts, I have talked about The Number – the amount that you need to have saved (preferably, invested in passive income-producing investments) by the time you retire.

Before we move on, it’s probably time for a quick review of what I mean by ‘retirement date’ because it’s not the same age-related date as most Personal Finance books and blogs assume:

‘Retirement Date’ = The Date YOU Choose to Stop Work!

… This is not 65 or any other age your boss, the government, or society tells you! If you are 35 years old and actually want to retire @ 65 on $1,000,000 a year this is NOT the blog for you!

Now, having got that one off my chest (!), one of my readers, who IS close to the traditional retirement age, asks a great question about how to figure his retirement benefits (which, he will receive as an annuity rather than a lump sum) into The Number for him …

… you can read his original comments here, but this is the essence of his problem:

I am just having trouble trying to quantify my pension so I can include it in my net worth … the trouble is I don’t receive a lump sum, but rather 65% of my base upon retirement, every year, which includes increases for cost of living every year.

The problem is that this reader was trying to find a way to calculate the ‘implied passive asset value’ of this pension into his Net Worth … while you could do that, there’s no real reason to.

If you are in a similar situation, what you really need to know is:

Can I live my ideal retirement on this pension … if not how much extra do I need to count on having in investments by the time I do want to retire?

To do that, we only need to make a slight modification to the formula we have used before.

1. STATE how much you need to live your ‘ideal retirement‘ assuming that you stopped work today (it’s not how much you would have, but how much you would need). What is that number?

2. DOUBLE that amount for every twenty years that you have left until retirement (add 50% if only 10 years, etc.). What is that number?

3. SUBTRACTthe annual value of any social security, annuities, pensions, or other regular amounts that you are reasonably (actually, very) certain to get. What is that number?

4. MULTIPLY your answer by 20 (slightly conservative) to 40 (very conservative). That is The Number … for you!

A couple of points:

I usually ignore Social Security and other government benefits, mainly because governments and regulations change … the longer until your chosen ‘retirement’ the more chance that these things will vaporize before you get there.

Similarly, I work on pre-tax numbers, because I have no idea what the tax regulations will be like …. the longer you have to wait until your chosen ‘retirement date’ the more chance that taxes will change (read: increase) before you get there.

But, these are only rough calcs to get you aiming towards a (probably) larger target than you previously figured on … as you get closer to your planned retirement, you will no doubt have had a number of sessions with a suitably qualified financial adviser who will figure out the exact effects of things like: inflation, taxes, social security.

Now, if you are still a fair way away from retirement (say 10+ years) you may want to figure in the impact of the pension on your Investment Net Worth.

You could multiply your expected yearly retirement benefit, again assuming that you were retiring today, by 20 (this time using the lower number means that you are being extra-conservative) and add this figure to your assumed Investment Net Worth.

You could also add it to your ordinary, garden-variety Net Worth to make 20% Rule decisions regarding how much ‘house’ you can afford.

You could do these things … but, I wouldn’t.

Why?

How certain can you be that you will qualify for any of these things in 10+ years?

What happens if you can’t work, get laid off, your company goes broke or it can’t meet it’s obligations, or … ?

The reason for these ‘rules’ is to ensure that you put your foot on the investment gas … now … and, hard!

Don’t use possible future company or government benefits as an excuse to over-spend and under-invest!

By the time you do retire, you’ll be glad that you didn’t …

STOP PRESS: Investor Finds Bank-Owned Bargains Galore!

Posted on April 3, 2008 by Adrian

I am (temporarily) shelving today’s post because a very interesting e-mail arrived in my in-box last night.

It was an e-mail newsletter from a foreclosure and real-estate listing service that I use, called RealtyTrac.

This particular article caught my eye, because I love anything that shows that real money is made when you ignore conventional wisdom; the headline read:

Investor Finds Bank-Owned Bargains Galore

“I just bought two brand new homes as REO from the bank,” said a Tennessee-based investor [Kirk Leipzig] in December. “I am buying five more new homes next week from the bank. I am buying $750,000 homes for $450,000 … This is the time to buy, and to make a killing out there,” continued Leipzig, who’s been a RealtyTrac subscriber for about nine months. “But you need to totally understand your market and educate yourself daily on your market. Then go buy, buy, buy.”

What’s most surprising about Leipzig is that he is not buying and holding – as many experts recommend in a down market – but buying and flipping.Now this really goes against conventional wisdom i.e. “housing prices are low … they can only go down … nobody is buying … you will be stuck with real-estate” …Maybe all true … maybe not … who knows? But, this guy has an answer for all of that:

“All the properties I currently buy are for flipping only,” he said, acknowledging that he always has a backup plan because of the difficulty selling in the current market. “I always buy a property now to flip, but in the back of my mind I know I can lease-option it, or rent it if it does not sell as quickly as I would like.”

I have to admit that ‘flipping’ real-estate is not in my particular comfort zone – I have never flipped anything (unless you call ‘buying’ majority share in a business for $0 down and ‘flipping’ it 18 months later for $6 million … but, that’s another story) …

However, for those of you looking to take some risk in what I would call The Business of Flipping Homes” as a somewhat risky way to make money in the short term (i.e. with a possible very large reward if you can replicate what this guy is doing) in order to then INVEST the excess proceeds into your long-term INVESTING (i.e. buy and hold) strategy, this just may be worth considering?

Whether you try and replicate what this guy does, in your own market, or try something else entirely different in the real-estate field “you need to totally understand your market and educate yourself daily on your market” …

… then, don’t just sit on your thumbs along with the rest of the herd … do as this successful business person does: go buy, buy, buy!

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Most people fail financially, not because their dreams are too big, but because their dreams are TOO SMALL.

Posted on April 2, 2008 by Adrian

How should you plan for your financial future?

Conventional thinking says to look at your current salary then it says that in retirement you need some larger-or-smaller percentage of that salary to live on – some people say that you need just 50% to 70% of your pre-retirement salary in retirement … others say 100% to 120% – hence you need a certain lump sum invested in a certain way to produce that weekly or monthly withdrawal.

Now, this may produce the RIGHT result for SOME people, but I believe that any resemblance to what MOST PEOPLE would want to retire on is purely coincidental.

Here are two examples – obviously extreme – to illustrate:

1. Less is more

Let’s say that you like surfing … in fact, if to surf every day and just ‘be one with the waves’ is your Life’s Dream, then, I say “go for it!” …

… Go ahead and cash in your 401k and other assets now, move to Byron Bay (Australia) and you can pretty much live the rest of your life on the beach, living off government handouts.

Plenty of people are happily living this ‘dream’ right now …

Requirement: 0% (give or take) of your current salary

2. More is more

In 1998 I had the audacity to imagine a life where I could be ‘free’ to travel physically, mentally, and spiritually … I costed this life in terms of:

(a) Time – I would need to retire within 10 years so that I would be free to travel where and when I liked,

And …

(b) Money – I would need about $250k a year in PASSIVE INCOME, indexed for life … my dream didn’t say that I couldn’t travel Coach!

The only problem, in 1998 I was running a struggling business employing 5 people, losing $5k a month, $30k in debt, drawing only $50k a year, and my wife still had to work … what’s more the business had been running that way for 5 years!

Requirement: 500% (give or take) of my (then) current salary

The outcome for me was positive (I didn’t just pick the name of this blog out of thin air!), I firmly believe BECAUSE I had a Big Dream. My challenge is now to shift from aiming towards it to actually living it.

But, the point here is that your LIFE should dictate your finances, not the other way around … dream first …

… only then, financially plan accordingly.

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Maybe Dale Carnegie was on to something?

Posted on April 1, 2008 by Adrian

In his famous book, How to Win Friends and Influence People (first published in 1936), Dale Carnegie – the great public speaker, personal improvement trainer, and prolific author – showed that success very much hinges on your ability to ‘influence people’.

In fact, as I think back, my greatest successes have been with people who have liked and admired me … and my greatest challenges have been with those who haven’t.

You can invent the greatest mouse-trap in the world, but nobody will beat a path to your door if they smell a rat 😉

This is Dale Carnegie’s summary of his own book; apply some of these ideas and you will succeed in life.

Remember, no matter what you do other people are the key to your success:

Part One

Fundamental Techniques in Handling People

Don't criticize, condemn or complain. Give honest and sincere appreciation. Arouse in the other person an eager want.

Part Two

Six ways to make people like you

Become genuinely interested in other people. Smile. Remember that a person's name is to that person the sweetest and most important sound in any language. Be a good listener. Encourage others to talk about themselves. Talk in terms of the other person's interests. Make the other person feel important - and do it sincerely.

Part Three

Win people to your way of thinking

The only way to get the best of an argument is to avoid it. Show respect for the other person's opinions. Never say, "You're wrong." If you are wrong, admit it quickly and emphatically. Begin in a friendly way. Get the other person saying "yes, yes" immediately. Let the other person do a great deal of the talking. Let the other person feel that the idea is his or hers. Try honestly to see things from the other person's point of view. Be sympathetic with the other person's ideas and desires. Appeal to the nobler motives. Dramatize your ideas. Throw down a challenge.

Part Four

Be a Leader: How to Change People Without Giving Offense or Arousing Resentment

A leader’s job often includes changing your people’s attitudes and behavior. Some suggestions to accomplish this:

Begin with praise and honest appreciation. Call attention to people's mistakes indirectly. Talk about your own mistakes before criticizing the other person. Ask questions instead of giving direct orders. Let the other person save face. Praise the slightest improvement and praise every improvement. Be "hearty in your approbation and lavish in your praise." Give the other person a fine reputation to live up to. Use encouragement. Make the fault seem easy to correct. Make the other person happy about doing the thing you suggest. Sound advice from one of the 'soundest advisors' of all time ... just wish I had paid attention sooner ... I would have been sitting on the beach, sipping pina-coladas 10 years earlier! AJC.

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How to avoid being 'house rich' yet 'cash poor' …

Posted on March 26, 2008 by Adrian

I recently read about a very interesting predicament for a reader on Free Money Finance – one that is, unfortunately, all too common.

Here is what the reader asked on the post on FMF:

To start off, my husband and I purchased our home in 1987 for a little over $100,000…..[ her husband died after a whole series of family tragedies]……The house is the only asset I have left and the only thing I have to pass down to our children.

Now, you will need to read the entire post on FMF just to understand the tragedies that this poor woman has had to endure …

…. on top of that, she now has to face an uncertain future because their only form of ‘financial planning’ was to own their own house.

This is an all-too-common story. In fact, I am reminded of two recent stories from my own family:

1. My wife’s mother died living on a government pension, no vacations, walked wherever she could, and otherwise penny-pinched to survive. Yet she died and left her three daughters (including my wife) a house worth nearly $800k and no mortgage!

2. My 95 y.o. grandmother (still living!) spends all of her income on supporting my mother and two sisters (all capable of working, but choose not to), struggles to pay her own bills (she had to borrow $40,000 from me to pay a Land tax bill). She gave my son a check for his birthday when we went to visit her last Christmas … the check bounced!

However, she just sold an investment property that she had held on to for many, many years (clearly, it became so run down that income was very low) for $4.5 Mill!

Kind of reminds me of the guy who lives like a miser but has a secret $1,000,000 stash of cash stuffed into his mattress.

These are examples of being ‘asset rich’ and ‘cash poor’ and, unfortunately, describes so many Americans reaching retirement age.

The solution is the 20% rule …

If you didn’t read the original post, this ‘rule’ says: have no more than 20% of your net worth tied up in your house (plus another 5% max. tied up in cars, furniture and other possessions).

That is simply another way of saying that you must have 75% of your Net Worth in income-producing assets (if you are at or near retirement age) or in a mix of income and growth assets (if you are at least 10 years off retirement).

If you are nowhere near retirement, and this will be your first home purchase … go ahead and break the 20% rule … but, reassess every year and make it your goal to build up enough free equity (that is, more than the 20% rule allows) … when you do, be sure to use that equity to invest or you will end up exactly where this post says you don’t want to be!

Having a house … and only a house … is no way to live.

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How to make 7 million in 7 years …

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