An introduction to Eurekonomics, Pt. 2Article added by Jeffrey Reeves on July 7, 2010

Jeffrey Reeves

Denver, CO

Joined: March 24, 2010

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EUREKONOMICS[tm]

Part one of this series introduced you to the idea of Eurekonomics. In part two, we'll look at the rate of return fallacies.

There are two deceptive mantras of the Behemoths that are blatantly false but unrelentingly repeated:
• Always seek the highest rate of return
• Average rate of return is a legitimate predictor of future performance
Seeking the highest rate

Chasing the highest return to make the most money in the least amount of time is an intentional distraction from the real issue. Americans are losing a great deal of their money unnecessarily, much more than they can recover with any reasonable rate of return. They are also taking unwarranted risks, which help to compound the problem.

The answer to this dilemma may be a question: if you plug the holes in a leaky bucket, how much easier is it to fill it up?

It seems like the only consistent alternative the Behemoths offer is to either directly or indirectly invest in the stock market. Their presentation sounds good. Wall Street says the S&P 500 and its predecessors have returned an average of 10.5 percent since 1871. However, no one actually earns that average.

You have to pick a tool -- a stock or mutual fund, for example -- to put money into the market. That tool determines your return, not what the S&P gets. You can base your decision on the history of the tool, but there is no guarantee you'll get that history. Often, it's worse.

The average rate of return

The average rate of return is a shell game that uses illustrations of hypothetical results to show a consistent seven percent to eight percent return over multiple intervals, usually annual.

A typical \$1,000 investment example used by this scheme with an average rate of return of 8 percent might look like this:
• Year 1 -- \$1,000 x 8 percent = \$1,080
• Year 2 -- \$1,080 x 8 percent = \$1,166
• Year 3 -- \$1,166 x 8 percent = \$1,260
• Year 4 -- \$1,260 x 8 percent = \$1,361
• Average rate of return = 8 percent
• Actual compounded annual return = 8 percent
However, even though this illustration shows an average rate of return of 8 percent over a four-year period, it is unlikely, if not impossible, to earn an actual 8 percent year upon year compounded return. (Just ask one of Bernie Madoff's clients if you don't believe that.) A more honest illustration of an average 8 percent return might look like this:
• Year 1 -- \$1,000 x + 40 percent = \$1,400
• Year 2 -- \$1,400 x + 22 percent = \$1,708
• Year 3 -- \$1,708 x - 15 percent = \$1,450
• Year 4 -- \$1,450 x - 15 percent = \$1,233
• Average rate of return = 8 percent
• Actual compounded annual return = 5.38 percent
Even though the returns in the gaining years far outweigh the negative returns in the losing years, the average rate of return is still 8 percent, while the actual compounded return is only about 5.38 percent. We could show a much lower actual compounded return -- even a negative return -- with a little bit of creative arithmetic, but this is enough to make the point: Average rate of return is always deceptive, is always hypothetical, and is never guaranteed.

General Motors vs. Enron -- Who wins?

Let's look at two investors: Joe And Mary. Joe was a risk-taker who heard about fantastic returns with a little Houston energy company called Enron. For six years, it kept going up and he kept investing both dividends and new money. The bad news eventually surfaced. The officers institutionalized lies about quarterly earnings. Their profits only occurred through "creative accounting". When regulators exposed the details, everyone's money evaporated, including Joe's.

Mary was more conservative. She wanted a place for her money that wasn't exciting, but would bring predictable growth year after year to fund her retirement. She put her money into General Motors stocks and bonds, a foundation of the U.S. economy for decades. Last year, when the recession came on full force, GM declared bankruptcy, the government took over and Mary lost 98 percent of her investment, even though she'd worked hard and done the right thing by saving her money in a "safe" place.

General Motors is not Enron, but the effect is nearly the same. Joe and Mary's results didn't occur because they put their money to work, but because they chose a tool that guaranteed only that it guaranteed nothing.

Neither Joe nor Mary is retiring anytime soon.

The tools EUREKONOMICS(TM) uses carry none of this risk. Not only do they guarantee your principle, but they also deliver a respectable, predictable growth that creates a financial foundation built on bedrock, not sand.

Once you build your foundation, eliminate your debt (we'll talk about that shortly) and save the money that you need to deal with life's surprises and secure your future and that of your heirs. Then, if you want to risk some, you can stick your toe back into the raging river that is the stock market with its level five rapids, unpredictable waterfalls, and occasional pools and eddies.

There are many plans that are "qualified" by the IRS to save for retirement and education: 401(k), IRA, 403(b), SEP, 457, 529, and more. All of these qualified plans operate in similar ways. Each of them places restrictions and limitations on you and your money. Consider these issues:
• "My qualified plan saves me taxes."
Does your plan save taxes or just postpone them? If the plan just postpones them, what will the taxes be when you need to live on that money? A tax deduction from the IRS is a loan payable to the IRS. You will have to repay that loan when, perhaps, you can least afford to at a rate that the IRS will determine at that future date. That's risky.

• "I can only put a limited number of dollars per year into the plan."
Will that much money grow enough to live on when you retire? How much risk will you have to take to give your money a chance to make that work? What if the market crashes just before you are ready to retire? Ask someone that planned to retire in 2002 or 2009.

• "If I take any of my money out early, I have to pay penalties and taxes and I lose all future growth on that money."
If you lose your job or become disabled and need some money until you're working again, why should it cost you? Who really benefits from this confiscatory policy? You are smart enough to only take it out if you need it and to put it back when you're able.

• "If I don't take it out by a certain age, I lose 50 percent."
Why should you have to spend the money if you don't need to? Isn't it because the federal Behemoth wants to make sure that you pay every dollar in taxes possible?

• "The only thing I can invest in is the stock market."
We've talked about this one. Do I want to trust my life savings to a speculative investment I don't control and that guarantees only that it guarantees nothing?
You don't have to wonder who these restrictions benefit. They benefit the Behemoths. You can also be assured that there's another way to approach saving for retirement.

A wheat farmer once explained the federal Behemoth programs for farmers and the many restrictions they imposed on the farmer. I remember him saying, "Once you put your land in, you can't get out." Maybe you should take his advice about your retirement savings. Maybe you'd be better off trusting your money to a less risky and less restrictive financial product and stay out of the programs foisted on Americans by the Behemoths.

Perhaps you, like many Americans, have money tied up in these programs. That's often the only choice you were given. However, by recognizing the disadvantages of these plans, you can now choose to grow your money elsewhere, with fewer restrictions and more benefits. You can now choose to minimize the negative effects of those qualified plans at the same time.