Retirement—maybe you’ve put a lot of thought into it, or maybe you haven’t. Yet chances are, you could be taking an even better approach, by saving more efficiently and combating wealth eroders you didn’t know existed. All it takes is a small paradigm shift. When it comes to your personal life, consider what’s most important to you—for me, that’s family. Then ask yourself, “Is the approach I’m taking to my personal finances able to fulfill my desires now and later?”
Too many of us are stuck thinking about what will happen “later” (retirement), that we forget about what’s happening in the present. If we spin our wheels saving for the unknown, we can miss out big time. I know that I want to make as many memories with my family as I can, right now. I also know that I want to contribute in a meaningful way to my future and theirs. By learning to plug financial leaks, you can enjoy the most important things in life now and still save for the future.
If you’ve been steadily saving for retirement, that’s fantastic. 10% is not unusual, and 20% is even better. Yet many Americans are finding saving to be a difficult pursuit, and many of the reasons are elusive. Likely, you’re spending a sizable amount on taxes, interest on your mortgage, home equity lines, college loans, credit card loans, and more. And that’s on top of your monthly living expenses. If you’re also looking to make memories now, that only adds to the pressure you may be feeling.
Growing your retirement nest egg can feel like an uphill battle with all of these other costs. And you can hope to earn interest on it, yet what about the little fees and expenses that quietly eat away at your accounts? If you could identify and chip away at these hidden wealth eroders, how would that change your life?
Could you take on less risk in your investments, or stop “chasing returns”? Would you have more certainty, and therefore more confidence? So much of the typical retirement savings advice places too much emphasis on risk, without really addressing the dangers. The phrase “more risk, more reward” has become a common battle cry of the typical advisor.
Instead, if you learned how to identify and wipe out those eroders, you could save more money, more efficiently. And in doing so, lower your financial stress and create the most wealth..
The Hidden Wealth Eroders:
1. Mortgage Refinancing
Everyone, including your mortgage company, is encouraging the general public to refinance at today’s record low interest rates. And while it’s hard to resist the allure of rock-bottom interest rates, it’s not always the ideal route.
In reality, low rates don’t always help you lock in low payments. Additionally, you can end up paying some pretty significant fees for the “privilege” of refinancing. At a minimum, you’re looking at 1% of the total loan, if not more. And if you look at a standard amortization table, you’ll see that when you refinance, you go back to the earliest years of the loan. That means you’re paying mostly interest, rather than chipping away at the principal. It’s not the interest rate that matters most, but the volume of interest you pay.
Ultimately there are personal factors to consider, but don’t let the allure of a low interest rate take precedence.
2. Investment Fees
Even with “no load” mutual funds, it’s common to see management fees at about 1%-2% of your account every year. And yes, even that 1% can do some serious damage—around a 20% erosion on the value of your account over 20 or 30 years. Imagine if that was a 2% fee.
There’s no better time than the present to take a hard look at the fees you’re paying on various accounts. I know many investors who didn’t even realize how much they were losing to fees each year, and the subsequent loss of compounding interest.
Once you’ve identified what fee you’re paying and where, ask yourself if you’re really getting more value because of those management fees and transaction fees. If they’re not adding value, there are plenty of other places to store your money that offer low fees and even better opportunities for growth.
3. Interest on Auto Loans, Credit Cards, Student Loans, and HELOCs
As I’ve come to understand, the way you use your money is more important than where you put it. Nothing demonstrates this more than the following quote from Nelson Nash, author of Becoming Your Own Banker. He says, “You finance everything you buy…you either pay interest or pass it up.”
There are two primary ways we finance things:
- We take on debt and pay back principal (with interest) or
- We pay cash and avoid the interest payments.
However, there’s a lesser known third option, which allows you to recapture significant interest costs. This way, your money grows and compounds in a safe vehicle over a long period of time, and can act as collateral to borrow from a financial institution. Having your money continuously earning will allow you to grab the power of compound interest.
4. Taxes
This is the biggest wealth eroder most of us face in our lifetimes. Imagine a single dollar, doubling every year. Believe it or not, you’d have $1,024 after ten years. Yet with a mere 10% tax rate on that money each year, you’d only see $613 in your account.
After 20 years, that account would grow to over $1 million before taxes, yet only $376,000 when you taxed it at the same, modest 10%. It’s even more sobering when you realize that you’re in a higher tax bracket, and taxes are likely to increase in light of the $26 trillion of government debt and unfunded liabilities for social programs such as Social Security and Medicare.
5. Term Life Insurance
Though useful for protecting your family against income loss, more than 98% of these policies never pay out. They’re not a wealth building asset. Not only do years’ worth of payments vanish, you generate no returns on that money. You forgo a large death benefit when the policy lapses, and term life insurance can be prohibitively expensive to maintain later in life (when you need it most and are guaranteed to use the insurance when you pass).
Term life is best used as a supplement to whole life insurance, for when you want maximum insurance. A properly structured whole life insurance policy has a number of benefits, including a tax-advantaged savings ability, which makes it an ideal alternative. Additionally, it’s permanent, meaning that you get what you pay for and your family is guaranteed to benefit.
Opportunity Cost
The reason these wealth eroders matter so much in the grand scheme of things, is because of opportunity cost. And there’s a significant cost for ignoring these fees—every unnecessary dollar you pay is a dollar you cannot use to make your money grow.
Think about it like a $5 cup of coffee. It smells and tastes good when you first receive it from your friendly barista. Yet that $5 had an opportunity to do more. If you took it and saved it elsewhere at 5%, that $5 could actually be worth $21.61 in 30 years, all without lifting a finger. That’s an expensive cup of coffee at the Opportunity Cost Café.
It seems small, but consider your much larger fees and the significance becomes clear.
The Alternative
So how do you recapture this lost wealth AND save on opportunity costs? The first step is to address these holes that can be plugged. The second step is to look to accounts that do more for your dollars without the risk and the fees.
Here are areas in which you can seek improvement:
Insurance Premiums
When it comes to your homeowner’s insurance and auto insurance, it’s tempting to keep your deductibles low so that you can keep costs down when making a claim. Yet consider the possibility you’ll make a claim—it certainly likely, but not something you’ll have to do often.
Suppose you raised your annual deductible form $250 to $1000? That would substantially reduce your premiums, and you could put away the savings in a high interest vehicle or use it to reduce other debts. Then, in the event you do make a claim, you can use those savings to easily pay the deductible. That’s why it’s so important to have an emergency and opportunity fund available so you don’t have to go into unnecessary debt to fund unexpected expenses.
Many neglect to review their policies frequently, and end up overpaying in premiums. By doing a yearly review, you can identify insurance you don’t use often and raise the deductibles.
Roth Conversion and Cash Value Life Insurance
If you have recently lost your job, or expect to have a substantial reduction in income this year, thus finding yourself in a lower tax bracket, now might be the ideal time to do a Roth Conversion. You might also consider it if you expect the government to raise taxes substantially in the future (a distinct possibility).
By rolling over your traditional tax-deferred IRA or SEP into a Roth IRA, you can pay tax now on your lower tax rate. As a result, you won’t have to pay taxes on the distribution in retirement. Note: Roth conversions do not have an income limit, yet you must be mindful that the conversion could put you in a higher tax bracket.
Another reason this might make sense is that Roth IRAs are not subject to required minimum distributions after age 72, unlike a traditional IRA. So if you’re fortunate enough not to need the distributions at that point in time, you’re free to let it grow. This can even be left to your heirs.
This is where cash value life insurance comes in. This method is a tremendous way to store safe dollars, and comes with significant tax benefits. Similar to a Roth IRA, money is contributed on an after-tax basis, and grows tax-deferred. Unlike Roth IRAs, there is no income limit for utilizing a cash value whole life policy, and your contributions can be substantial. There are also no government restrictions on when and how you’re able to use your cash value, since it is a private account with the insurance company.
Even better, you can continue to grow your funds while utilizing the dollars as collateral through a policy loan. This is a tax-free way to leverage your money without withdrawals. This allows you to your other people’s money while yours gets to compound uninterrupted. The funds can be used to fund college or automobiles and provide capital to invest in options that require lump sums.
And lastly, the death benefit, which is many times the cash value, is passed tax-free to your beneficiaries. This allows you to leverage a large asset with smaller dollars. For more information on how whole life insurance works, watch my video.
Make the Most of Your Dollars
These are uncertain times, and it’s easy to start heading down a dark path in our own thoughts. The economy looks different, our daily lives look different, and our businesses look different—and it’s uncertain how things will continue to change in the next year. However, the key to navigating times like these, is to focus on things that offer certainty, so that we can continue to pave a path of progress and prosperity.
Success lies not in what happens to you, but in what you can control. No philosophy addresses this better than Stoicism, the center of which advocates for individuals creating a strong internal locus of control. If we unpack that, it boils down to a belief that individuals are responsible for their own success or failure in this world. That life puts forth a challenge, and then asks, “What will you do about it?”
Ultimately, the most financially satisfied people in our nation are the ones who know how to make their dollars work for them—to seize control and responsibility, no matter their external circumstances. This, more than anything else, is the secret to financial independence. You don’t need to build mountains, you need only optimize what you have. If you, or someone close to you, suspects your money is not working as hard as it could, don’t hesitate to call.
To discuss strategies that will help you keep more of your wealth, schedule an appointment here.
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