Beware of financial evaporation
By Peter “Coach Pete” D’Arruda
“A big part of financial freedom is having your heart and mind free from worry about the what-ifs of life.” — Suze Orman
When it is my turn to tell the bedtime stories in our family, I have a limited, but highly effective arsenal of tales guaranteed to make my daughter’s eyelids grow heavy and close within 10 minutes. I know nothing of hypnotism, but I am convinced that it is the cadence and the tone with which I read these stories that makes them so effective as a sedative. One of Caroline’s favorites is "The Little Engine That Could."
It is the stirring saga of a small, underpowered steam locomotive that bravely volunteered to pull a long train over a high mountain, and could only accomplish the seemingly impossible task by repeating the optimistic chant, “I think I can, I think I can.” Sure enough, through hard work and positive thinking, the objective is met and the little engine emerges a hero. Unfortunately, (or fortunately, depending on your point of view,) little Caroline usually falls asleep before the part where the little engine proudly chugs into the train yard to the cheers of his railroad pals.
During our accumulation years, while we are still working and saving, we are called upon to haul freight uphill, as it were, in preparing ourselves for retirement. In our younger years, it may be a struggle to chunk away the money we know we ought to save. We are hardwired for having fun. Every cell in our body and every neuron in our brain is thinking of ways to live beyond our means.
Then, along comes a family, and our resources seem to be stretched as thin as cheap cellophane. But, like the little engine that could, we give it a go. We chug along. We stick to the program. Then, a magical thing happens along the way. Slowly but surely, we get something called momentum. Our capacity to earn becomes greater the more experience we acquire. Our little nest egg begins to grow exponentially; that is, the bigger it gets, the bigger it can get.
Because of the miracle of compound interest, what started slowly begins to pick up speed. We keep pressure in the boiler, we keep our eyes focused on our goal and before long, the Law of Inertia begins to work in our favor. Our money is begetting money, which, in turn, begets more money, until we are at last on top of our personal mountain saying, “I knew I could, I knew I could.”
Inertia and compound interest
Galileo, a 17th-century scientist, figured out that it’s easier to keep something rolling once you have it rolling than it is to get it rolling in the first place. Sir Isaac Newton came along a few years later and named it the Law of Inertia. A body in motion will tend to remain in motion until it is acted upon by an outside force. It’s the same way with money. The first few years of accumulating money are the hardest. After that, if we keep on accumulating and investing wisely, it gets easier. Have you ever heard the saying, “The rich get richer?” Well, they weren’t kidding. It’s a natural law of economics that the more we have, the faster it grows, especially when compound interest is involved.
The power of a penny
The story is told (fictional, I’m sure) of a job interview where the applicant is offered a job and asked to choose between two pay plans. One compensation plan would pay a straight $1,000 per week. The second plan would pay you a penny per day, doubling every day. That’s right, first day on the job nets you a penny. That amount doubles on day two and every day thereafter so that by the end of the first week, you have earned a whopping 64 cents. Bad deal, right? Not really. With the penny-doubling-every-day pay plan, you will have earned over $5 million by the end of the month!
If you are skeptical of the math, just get out your calculator and a calendar and check it. It’s true! By the 30th day, you have 536,870,912 pennies. That’s a cool $5,368,709.12.
A penny doubling every day is, in essence, earning 100 percent interest paid daily. While that is unrealistic, it does illustrate the value of momentum when it comes to money — how even a small amount, over time, can lead to a surprisingly large growth through the miracle of compound interest.
Albert Einstein is often credited with saying, “Compound interest is the eighth wonder of the world. He who understands it, earns it. He who does not, pays it.” Whether the German-born American physicist actually said that or not is still debated, but it doesn't negate the truth of the quotation. Compound interest occurs when interest is added to the principal, so that from that moment on, the interest that has been added also earns interest.
If we are to arrive at a ridiculously reliable retirement income, we must keep our eyes peeled for something called financial evaporation — the slow and often imperceptible disappearance of our assets that occurs when we aren’t looking, or aren’t looking closely enough.
Which brings us to the tadpole story.
Summers were long, hot and sometimes boring in the little milling community in North Carolina where I grew up. If you’ve ever seen the old black and white reruns of "The Andy Griffith Show," you have a pretty clear idea of the bucolic setting in rural America that surrounded me as a 10-year-old boy. Since my brothers and I did not have much to do, or much to do it with, we invented ways to amuse ourselves. Our favorite play area was a bog near our house where a slow-running creek fed a small swamp. Working like beavers, we dammed up the creek until we had a pond deep enough to swim in. We boys were intrepid souls. Because we were utterly unaware of them, we were quite unafraid of the dangerous water moccasins that lurked in those waters. A bit further down the food chain were the harmless amphibians with which we shared our aquatic playground. One warm spring day, we discovered in one of the shallow pools near the creek what seemed like millions of little swimmers we would later identify as tadpoles. This was before the Internet and the Discovery Channel, so we had no idea what they were at first.
We found some jars and scooped up a few scores of the soon-to-be frogs and took them home. Since our mother did not take too kindly to having them inside the house, we found an old dog food bowl outside and made that their new home, putting it well out of the dog’s reach, of course.
“Those aren’t fish,” my father told us. “Those are tadpoles. They will turn into frogs in a few weeks … if they live long enough.”
I think he knew something about the attention span of young boys.
“I would advise you to keep them out of the hot sun,” he warned.
Over the next few days, we checked on our little swimmers, who at the time, seemed very happy. We noticed that they were getting a bit fatter and that some of them had developed little paddles that were the beginnings of frog legs.
We had put them in the shade, just like Dad had said. What we did not count on, however, was the shade moving as the sun made its arc across the sky. One morning, after a particularly hot day, we checked on the tadpoles, only to discover that the bowl was bone dry and coated with what looked like small, whip-shaped leathery decals stuck to the sides of the bowl.
Poor little critters. The heat of the sun had caused the water in the bowl to evaporate, ending any chance our tadpoles had at eventual froghood. Our neighborhood pals who lived next door had better success with their tadpoles. They kept their bowl full of water, and their little tadpoles were still swimming.
I learned a valuable lesson about caring for tadpoles — evaporation happens. In hindsight, we boys should have moved those tadpoles into a bigger bowl. We should have added water to the bowl. We should have paid more attention.
If we aren’t paying attention, the same thing can happen to us in a financial sense. All too often, I have seen people build up a nice portfolio that took decades to acquire. They counted on these retirement accounts to be there for them when they made their metamorphosis into retirement. Then, evaporation happened. Sizable portions of that reserve disappeared. Was it because they didn’t pay enough attention? Did they trust someone else, perhaps a broker, to look after things for them? Did they forget that as they grew older, their risk tolerance would change? Was their ship on autopilot when they should have been tending the wheel? Was their fortune placed in the hands of a financial professional who worked according to some cookie-cutter investing formula that did not take their age into account?
The best expression I have heard for making sure that evaporation doesn’t erode our retirement savings is “future-proofing.” It reminds me of how we coat something with insulation if we want to weatherproof it. Future-proofing boils down to something as simple as adhering to one of the oldest rules of investing — the rule of 100. Just put a percent sign after your age. That is the amount you should have in a safe place — in the shade — to protect it from financial evaporation.
Safe does not have to be boring, as I will explain in future articles. That precaution will prevent you from risking money you cannot afford to lose. A competent financial advisor will be able to identify programs for you that are designed specifically for those approaching retirement — income planning programs that replenish the account each year, regardless of outside forces such as the stock market and world events.
Had we D’Arruda brothers taken the proactive steps of checking on our tadpoles more frequently and refilling their bowl with creek water more often, our tadpoles would have survived metamorphosis. The “set it and forget it” approach may work well in our early years of investing simply because time is on our side, but as we approach retirement, we have to be proactive with our accounts if we want them to thrive and grow.
Evaporation takes many forms. It can take the form of unnecessary fees, commissions, and needless losses. What’s wrong with this statement? “I don’t feel bad about my broker losing so much money in my account because everyone else has lost money, too.” Really? Is that how you feel, or is that how you have been programmed to feel? Is the automatic response from your broker one of consolation based on shared experience?
When you point out that you pay the same exorbitant fees when your account loses money as you do when it gains, do you receive thorough explanations and solutions? Or do you hear expressions such as:
“Don’t feel like the Lone Ranger.”
“You’re not the only one.”
“Everybody’s in the same boat.”
Don’t buy it. Just like those tadpoles that were sensitive to their environment and needed repositioning for their safety, your money needs to be rebalanced and repositioned so that the account won’t suffer from either the sunstroke of high risk, or the slow, imperceptible evaporation that comes from unnecessary fees and commissions.