WHERE DO PROBLEMS START – THE PREMISE

In the past, traditional thinking has used the same premise when it comes to your personal financial planning. That premise or process for growing wealth has not changed over the past 60 or 70 years. The lesson is, if you attempt to measure accuracy and success with a tool that is not precise, how legitimate can the measurement be? If, from the beginning, the premise is flawed and the formula of measuring is incorrect, what are the chances of achieving a desired goal in the future? Measuring your financial success is not different.

The basic premise for achieving traditional financial success continues to follow the formula that money, times the rate of return, times a number of years will result in predicting future dollars. Although this premise is correct mathematically, over a period of time, results of this premise are hardly precise. The premise relies on the idea that there will be a consistent flow of money, a consistent rate of return on that money and that the money will grow over a period of time. By following this formula, money will grow over a period of time. By following this formula, the hope is that you will achieve a favorable accumulation of money in the future. This formula is the center point of the traditional-thinking premise. Unfortunately, this premise is doomed from the beginning. It is hard to get the right solution when you start out with the wrong premise. Here is an example of a traditional-thinking formula:

The premise in this example is absolutely correct. This math is right, but can you count on that $305,204 and the value of that money being there in the future? I wouldn’t. This premise or type of thinking is centered on predicting an outcome and not planning for an outcome, and there lies the problem. Although the example looks simple, a lot of things can change over a period of 40 years.

First, let’s explore this example carefully. If you actually did accumulate $305,204 over that period of time, you might be able to say that traditional thinking and the premise that was used proved to be correct. Although the premise achieved its mathematical goal, now take into consideration that during that 40-year period inflation averaged 3%. If 40 years ago you thought $305,204 would be a good foundation for retirement, you would have to accumulate $995.586 in the future to have the buying power of $305,204. In 40 years, you will need about $305,204 just to pay the tax on $99,586. How useful is the premise without considering inflation?

Let’s take a different look at the example. If the $200 a month was put in an IRA or qualified retirement program and if the program earned 5% for 40 years, you would accumulate $305,204. Now, to get to this

money, you would have to pay taxes when you take the money out of (non-Roth). The after-tax value of

this qualified plan could be reduced dramatically. Since we don’t know what the tax bracket will be in the future, let’s just assume one-third of this accumulation will go to taxes. You would now have an after-tax value of $201,434. If you used a 3% inflation factor, the buying power of $201,434 in 40 years from now would be $61,750. Now how are you doing? Once should also be concerned that the premise and example we used occurred with not market losses over a 40-year period.

Although the premise is correct, there can be other consequences that could impact the overall results. Still, you need to be congratulated for any attempts you may have made in the past in trying to prepare for the future. With the information you had at that time, you probably made the best decisions you could.

So, if you receive more information and knowledge, you may want to rethink some of the decisions your made in the past. Much of the traditional being used today can result in unintended consequences.

RATE OF RETURN OR RISK OF RETURN

Traditional thinking relies mainly on the “rate of return” factor to measure financial success or failure.

Simply using the “rate of return” factor as a measurement of success or failure is a false premise. Rates of return are often misleading and misunderstood. Rates of return are a reflection of the past, not the future. It is the equivalent of you driving to work every day and never taking your eyes off the rear-view mirror. Rates of return are a measurement of where you have been, not where you’re going.

In order to change traditional thinking, it will be necessary to change the whole thought process. In the past, financial planning used the premise that money multiplied by a rate of return over a period of time equals results. The problem with “rate of return” is the lack of consistency from year to year or over a long period of time. Since 1929, the Dow Jones Industrial Average, on year-by-year results, has produced negative rates of return about one-third of the time. Experiencing a down market just before your retirement could impact your entire retirement savings. Perhaps the premise for planning your future should also include a “risk of return” factor. As you get older, the risk of return becomes very important. The older you are, the less time you have to overcome any downturns in the marketplace.

The competition and marketing by financial companies is centered around achieving higher rates of return for you. In promising higher rates of return, who is the one at risk, you or the company that says they can get you that higher rate of return? Your “risk of return” is an important factor in the way you approach your future.