re: Are any of y'all anti- 401K or IRAPosted by TheWiz on 5/3/13 at 9:45 am to LSURussian
Another of his spills:
This note will quickly illustrate what you're not being told. In most cases, you not being told isn't due to intentional misleading, but simply to not applying math to the situation.
Allow me to explain the "Lies of Averages". If you take the gross market returns (no fees) of the S&P 500 from 1980-2012, you'll find that the index has averaged 12.55%. This sounds great. You'll sit down with your advisor or you'll jump on a financial calculator and insert 12.55% for the average return and determine if you put $205 into your 401(k) you'll be a millionaire in 33 years! You'll think, "I'm all taken care of!"
The reality is far from the fiction. For the simplicity of math, I'll assume a starting balance of $10,000 and no additional contributions. The ending amount isn't the point...it's the principle that I'm want you to grasp.
I'll start out describing the perfect investment. The perfect investment is one that has no losses, no fees and no taxes. Today, want you to focus in on the losses and the fees part. We'll dig into taxes on a later date.
Using the perfect investment scenario, you sit down with your advisor and he shows you that the market has average 12.55% over 33 years and your $10,000 will grow to $494,767 because that is what the market has averaged. True, it did average 12.55%. But average and actual (you spend actual) are two different beasts when you deal with scenarios that you can have losses in.
Here is a quick illustration: Add 100% gain plus a 50% loss. What is the average? What can you spend?
Back to the prior example. The perfect investment at 12.55% average has your $10,000 growing to $494,767 in 33 years. However, the real ending value (factoring real gains and real losses) has you at $323,889! The losses cost you $170,878! Recall the conversation that you probably had with "your guy"..."Hang in there, the markets will come back, they always do, you just have to ride it out, don't bail out now...." This advice sounds great, but in real life it cost you $170,878! How many years of retirement income is that for you?
Now do you see what I mean when I say the "Lies of Averages"?
Let's apply fees to the "Lies of Averages". The average expense ratio in a 401(k) is about 3%. Some more and some a bit less. The more aggressive the fund, the higher the fees. Other plans have much higher fees (I've seen some 403(b) plans as high as 5%).
When applying the fee to the 12.55% gross average return of the S&P 500 you are left with 9.55% average. The perfect investment scenario (no losses) would have your $10,000 growing to $202,767. However, the real numbers have your $10,000 only growing to $129,402!
If you recall, at 12.55%, $205 per month for 33 years would have you at $1 million dollars! Add in the 3% fee and this number is reduced to $522,505 AND this doesn't even include accounting for the losses! The fees have cost you nearly $500,000! How many years of retirement is that? With six losses in 33 years for the S&P 500, this $522,505 would be around $260,000 after factoring in those losses!
Let's role play for a moment. You're 33 years old and you walk into a Wall Street advisor's office or you pull up the financial calculator on your online 401(k) account and you figure you want $1 million when you're 66. You see that the market has average 12.55% and you decide to put in $205 into your 401(k) plan or other retirement account. In your mind, you're all set and you rebuff any person's attempt to shed light onto your situation because you're convinced that "you're all set". Fast forward 33 years and you're 66. You've ridden the wave of ups and downs and you got the advice from everyone to "hold on, ride it out, the markets will rebound" and now you're 66 years old. You look at your account to see that you only have $260,000 in real money (that will be taxed at a yet-to-be-determined tax rate when you pull it out). A far cry from that $1 million your calculator told you that you'd have.
What do you do now? Back to work. You put off all of your dreams to age 66 only to find out what you were told isn't true and isn't a reality. According to the Census Bureau, of the people that started working at age 25 and are now turning 65, 1% is wealthy and 4% have enough put away for retirement. Of the remaining 96%, 29% are dead. That leaves 67% dependent on government (Social Security), family (their adult children), friends, charities and employment.
A bit of a side note, the IRA was created around 1974 and the 401(k) in 1980. People turning 65 today were about 25 when the IRA was created by ERISA in 1974...could the lack of financial security with today's crop of new retirees be a coincidence?
There are better options. Let's sit for 20-25 minutes and we can go over these options and you can decide for yourself if you want to pursue it further. I bet the old guy at Walmart or the elderly lady wiping down the tables at Wendy's (we've all seen them), didn't "plan" on being there when they were retired either.