Save or invest?
By Rodney Ballance
The Financial Leadership Academy
Why am I constantly worrying about the stock market going up or down every week for such low returns? Why does it seem like everyone is telling me I can do better than simply earning interest on my money? The answer isn’t what you want, but here it is. Earning interest isn’t sexy. That’s the bottom line.
As of June 10, 2011 the Dow Jones Industrial Average was up 8 percent over the past 10 years. This means if you had invested $100,000 10 years ago tied to the DJIA, you’d have $108,000 today. The S&P 500 is up 5.6 percent, so your $100k investment would be worth $105,600 today. That’s amazing. An 8 percent return is what you want, right?
Those losers who tried to get you to put your money into an account earning just 5 percent interest 10 years ago were crazy.
Really? If you had invested that same $100,000 in a savings tool during the exact same time period earning just 5 percent compound interest, your value today would be $164,320 — a 64.3 percent return. Albert Einstein said “The most powerful force in the universe is compound interest."
The law of compound interest is this mathematical equation: M=P( 1 + i )n. The law relating to investing is this legal disclaimer: “Past performance is no guarantee of future results.” This is the phrase every licensed investment professional must tell you, according to the Securities and Exchange Commission. In real life terms, this means buyer beware, but the way they say it sounds better, right?
Why didn’t I know this stuff, you ask? Why isn’t my banker telling me this? Why am I constantly worrying about the stock market going up or down every week for such low returns? Why does it seem like everyone is telling me I can do better than simply earning interest on my money?
The answer isn’t what you want, but here it is. Earning interest isn’t sexy. That’s the bottom line. If it’s not exciting and new, it can’t be as good for you as the new and improved financial tools. Why does “New Coke” come to mind when I say this? Hmmm...
I’ve been licensed to sell mutual funds and, because of extensive training, I fully understand how they operate, and what their purpose truly is.
A mutual fund is like a timeshare for investing. You don’t have to buy the whole share of stock in any particular company and consequently, you never receive the full benefits of owning that complete share of stock — specifically, quarterly dividends.
Just like a timeshare is a perfect vacation alternative for some people, it’s a horrible idea for others. Mutual funds have been sold to us as the perfect investment, but they’re not for everyone. Did you realize that before 1980, there were less than 200 mutual funds in existence? In 2011 there are over 20,000 mutual funds. You might tell me that the sheer number of these funds prove that these are the perfect financial tools. I’d argue that the only reason for this explosive growth in these financial tools is the implementation of the 401(k) as a retirement planning program.
Ted Benna, a tax consultant, was hired to find a way for a large bank to eliminate their traditional pension plan in 1980. He found the little used IRS tax rule in Section 401(k) that allowed high wage earners to defer taxation on a portion of their retirement savings. He said in a 1981 Time Magazine article that he knew this would not benefit most working Americans, unless the employer matched those contributions. Do not contribute any more than is being matched by your employer to a 401(k).
The IRS loved this use of 401(k)s because it allowed them to receive more money when people retired than typical payroll tax while they work. They knew there would be higher tax revenues when people had no deductions for children at home or a mortgage, and possibly at a higher tax rate.
The business community loved it because the employer saves 7.65 percent in FICA contributions for every dollar an employee contributes to any pre-taxed deduction.
The ones who love it the most are the financial advisers who have gotten very wealthy by setting up these payroll retirement plans. They used mutual funds because they allow people to invest smaller amounts from their paychecks with a promise of a high return when they retired. Maybe as much as 8 percent to 12 percent, right?
The use of mutual funds has allowed the financial services industry to rake in more money than any other industry in the history of the world.
Who’s left not to like this system? You, when the market’s down. Did you realize that American workers have over $4 trillion in mutual funds with 401(k) accounts alone? This staggering number is worth a better look at mutual funds. I certainly can’t teach you everything I know about this or any financial tool within the confines of this brief article, but I encourage you to learn more.
If you want to invest, there are more practical and efficient ways to do it than through mutual funds. Ask the next multi-millionaire you see which mutual funds they own. I guarantee you they’ll say none.