Below, you will find many of the mistakes which people make with their financial planning and investing. I say DON'T because in all the cases I have seen, these methods can cause a lot of unnecessary problems. If someone claims that they can demonstrate that one of these procedures will work for you, make him put his "proof" in writing. Then, send me a copy of that "proof" so that I can show you what is wrong with the "proof"
The following subjects are discussed below.
Look for the titles highlighted in this color:
Systematic Withdrawal
Variable Annuity 5% Guaranteed Income Benefit
Target Date Funds, Lifecycle Funds
Pension Max
Stretch IRAs
Fear and Greed are not the Problem - Don't Be Lazy
What Diversification Can and Cannot Do
Don't do ROTH Conversions
Monte Carlo Analysis are Misleading
Systematic Withdrawal
Mutual Fund and Variable Annuity prospectuses tell you how easy it is to set up that monthly check, but they do not disclose that there is risk. Almost half the public (43%) believes that they can withdraw 10% a year from their investments. Financial Planners know that you can only withdraw about 4.5% a year without risking bankruptcy.
It is a fact that in 1929 or in 1937, a 6% Systematic Withdrawal plan completely wiped out your life savings! Slick salesmen will show you that in the 1969 or 1973 "crashes" a 6% Systematic Withdrawal sufferred great losses, but ultimately survived. That is true, but not the whole truth. Systematic Withdrawal would have failed again except that in 1974 the oldest of 76 million Baby Boomers began to invest aggressively and flood of new investors buying stocks saved the Systematic Withdrawal plans. For 18 years, 1969 through 1987, you did not know what the result would be. If you retired in 1969, you would have spent your whole retirement worrying that you would run out of money before you died! Nobody needs that much heartburn.
The problem stems from the fact that people think they are only withdrawing profits from the account when they use Systematic Withdrawal. When the market is going down, you are withdrawing assets from the account. As a result, you cannot use Systematic Withdrawal to provide your basic retirement cash flow needs. The correct way to create your cash flow needs is to use some of your assets to create enough guaranteed cash flow for you to live in reasonable comfort. Then you can supplement that guaranteed income with profits from your investments when there are actual profits to withdraw.Click on the Retirement Planning section above in order to read a more thorough explanation of this planning technique.
Understand what motivates the salesman to push Systematic Withdrawal. If you use some of your assets to create a guarantee cash flow, that money is no longer available to generate commissions or fees for your financial advisor. The Mutual Funds and Variable Annuities will no longer receive management fees on that money either. They argue that "you lose control of your money", but what they really mean is that they lose control of your money!
There is a formal way use your assets to provide your retirement income. Click on the words Retirement Planning at the top of this page for more information.
The data below shows the performance of various Mutual Fund accounts under a Systematic Withdrawal plan. Basically, $10,000 was invested,a and 6% was withdrawm ($50 per month = $600) All of these illustrations led to bankruptcy of the accounts. All data was provided by the Mutual Funds themselves.
Mass Investors Trust A Putnam Investors Fund A State Street Research Investmen Trust A
Sales Load 5.75% Sales Load 5.75% Sales Load 4.50%
12b-1 Fee 0.35% 12b-1 Fee 0.35% 12b-1 Fee 0.00%
Investment 10000 Investment 10000 Investment 10000
Withdrawal Balance Withdrawal Balance Withdrawal Balance
12/31/1928 9370 12/31/1928 9430 12/31/1928 9550
12/31/1929 600 8075 12/31/1929 600 8525 12/31/1929 600 8379
12/31/1930 600 5495 12/31/1930 600 5664 12/31/1930 600 5970
12/31/1931 600 2715 12/31/1931 600 2749 12/31/1931 600 3864
12/31/1932 600 1978 12/31/1932 600 1687 12/31/1932 600 3294
12/31/1933 600 1919 12/31/1933 600 1756 12/31/1933 600 4410
12/31/1934 600 1508 12/31/1934 600 1188 12/31/1934 600 3921
12/31/1935 600 1290 12/31/1935 600 854 12/31/1935 600 4704
12/31/1936 600 988 12/31/1936 600 509 12/31/1936 600 6141
12/31/1937 600 210 12/31/1937 483 0 12/31/1937 600 3734
12/31/1938 200 0 12/31/1938 600 3697
12/31/1939 600 3097
12/31/1940 600 2176
12/31/1941 600 1478
12/31/1942 600 1111
12/31/1943 600 791
12/31/1944 600 301
12/31/1945 318 0
Alliance Growth & Income (A) Eaton Vance Traditional Investors Eaton Vance Traditional Stock Fund
Sales Load 425.00% Sales Load 5.75% Sales Load 5.75%
12b-1 Fee 0.35% 12b-1 Fee 0.00% 12b-1 Fee 0.00%
Investment 10000 Investment 10000 Investment 10000
Withdrawal Balance Withdrawal Balance Withdrawal Balance
12/31/1936 9563 12/31/1936 9430 12/31/1936 9432
12/31/1937 600 5586 12/31/1937 600 5459 12/31/1937 600 5867
12/31/1938 600 6305 12/31/1938 600 5893 12/31/1938 600 8549
12/31/1939 600 5405 12/31/1939 600 4985 12/31/1939 600 5834
12/31/1940 600 4525 12/31/1940 600 3979 12/31/1940 600 4780
12/31/1941 600 3592 12/31/1941 600 3059 12/31/1941 600 3715
12/31/1942 600 3375 12/31/1942 600 2901 12/31/1942 600 3521
12/31/1943 600 3538 12/31/1943 600 3072 12/31/1943 600 3895
12/31/1944 600 3593 12/31/1944 600 3025 12/31/1944 600 4155
12/31/1945 600 4109 12/31/1945 600 3468 12/31/1945 600 4624
12/31/1946 600 3413 12/31/1946 600 2816 12/31/1946 600 4067
12/31/1947 600 2898 12/31/1947 600 2130 12/31/1947 600 3421
12/31/1948 600 2321 12/31/1948 600 1595 12/31/1948 600 3022
12/31/1949 600 2084 12/31/1949 600 1214 12/31/1949 600 3141
12/31/1950 600 1856 12/31/1950 600 709 12/31/1950 600 3127
12/31/1951 600 1502 12/31/1951 600 173 12/31/1951 600 3094
12/31/1952 600 1078 12/31/1952 174 0 12/31/1952 600 2874
12/31/1953 600 459 12/31/1953 600 2313
12/31/1954 531 1 12/31/1954 600 2754
12/31/1955 600 2359
12/31/1957 600 1587
12/31/1958 600 1442
12/31/1959 600 957
12/31/1960 600 339
12/31/1961 386 0
Investment Co of America Evergreen Small Co S4 Evergreen Mid Cap Growth S3
Sales Load 5.75% Sales Load 0.00% Sales Load 0.00%
12b-1 Fee 0.00% 12b-1 Fee 1% 12b-1 Fee 0.0034
Investment 10000 Investment 10000 Investment 10000
Withdrawal Balance Withdrawal Balance Withdrawal Balance
12/31/1936 9425 12/31/1936 9995 12/31/1936 10000
12/31/1937 600 5416 12/31/1937 600 3178 12/31/1937 600 3799
12/31/1938 600 6099 12/31/1938 600 3213 12/31/1938 600 4191
12/31/1939 600 5507 12/31/1939 600 1824 12/31/1939 600 2436
12/31/1940 600 4737 12/31/1940 600 966 12/31/1940 600 1511
12/31/1941 600 3796 12/31/1941 600 213 12/31/1941 600 770
12/31/1942 600 3750 12/31/1942 223 0 12/31/1942 600 189
12/31/1943 600 4328 12/31/1943 235 0
12/31/1944 600 4672
12/31/1945 600 5682
12/31/1946 600 4981
12/31/1947 600 4386
12/31/1948 600 3803
12/31/1949 600 3498
12/31/1950 600 3514
12/31/1951 600 3502
12/31/1952 600 3276
12/31/1953 600 2666
12/31/1954 600 3404
12/31/1955 600 3595
12/31/1956 600 3359
12/31/1957 600 2417
12/31/1958 600 2759
12/31/1959 600 2509
12/31/1960 600 1985
12/31/1961 600 1796
12/31/1962 600 957
12/31/1963 600 519
12/31/1964 576 0
Evergreen Growth & Income S-1 Mass Investors Trust A Mass Investors Growth Stock A
Sales Load 0.00% Sales Load 5.75% Sales Load 5.75%
12b-1 Fee 0.57% 12b-1 Fee 0.35% 12b-1 Fee 0.35%
Investment 10000 Investment 10000 Investment 10000
Withdrawal Balance Withdrawal Balance Withdrawal Balance
12/31/1936 9998 12/31/1936 9424 12/31/1936 9443
12/31/1937 600 5884 12/31/1937 600 5901 12/31/1937 600 5619
12/31/1938 600 6205 12/31/1938 600 6622 12/31/1938 600 6243
12/31/1939 600 5357 12/31/1939 600 5876 12/31/1939 600 5595
12/31/1940 600 4362 12/31/1940 600 4732 12/31/1940 600 4402
12/31/1941 600 3347 12/31/1941 600 3757 12/31/1941 600 3391
12/31/1942 600 3082 12/31/1942 600 3627 12/31/1942 600 3320
12/31/1943 600 3023 12/31/1943 600 3904 12/31/1943 600 3555
12/31/1944 600 2853 12/31/1944 600 4054 12/31/1944 600 3729
12/31/1945 600 2946 12/31/1945 600 4673 12/31/1945 600 4487
12/31/1946 600 2227 12/31/1946 600 3872 12/31/1946 600 3634
12/31/1947 600 1725 12/31/1947 600 3340 12/31/1947 600 3126
12/31/1948 600 1157 12/31/1948 600 2783 12/31/1948 600 2561
12/31/1949 600 690 12/31/1949 600 2661 12/31/1949 600 2346
12/31/1950 600 169 12/31/1950 600 2695 12/31/1950 600 2413
12/31/1951 180 0 12/31/1951 600 2658 12/31/1951 600 2390
12/31/1952 600 2401 12/31/1952 600 1887
12/31/1953 600 1782 12/31/1953 600 1210
12/31/1954 600 1981 12/31/1954 600 1140
12/31/1955 600 1801 12/31/1955 600 757
12/31/1956 600 1379 12/31/1956 600 266
12/31/1957 600 667 12/31/1957 268 0
12/31/1958 600 226
12/31/1959 200 0
Putnam Investors Fund A Safeco Equity Fund State Street Research Investment Trust A
Sales Load 5.75% Sales Load 0.00% Sales Load 450.00%
12b-1 Fee 0.35% 12b-1 Fee 0.00% 12b-1 Fee 0.00%
Investment 10000 Investment 10000 Investment 10000
Withdrawal Balance Withdrawal Balance Withdrawal Balance
12/31/1936 9429 1/31/1937 10000 12/31/1936 9550
12/31/1937 600 5734 12/31/1937 550 5533 12/31/1937 600 6057
12/31/1938 600 6461 12/31/1938 600 6403 12/31/1938 600 6418
12/31/1939 600 5266 12/31/1939 600 5203 12/31/1939 600 5849
12/31/1940 600 4062 12/31/1940 600 4247 12/31/1940 600 4640
12/31/1941 600 3189 12/31/1941 600 3190 12/31/1941 600 3794
12/31/1942 600 3371 12/31/1942 600 3032 12/31/1942 600 3927
12/31/1943 600 4088 12/31/1943 600 3405 12/31/1943 600 4414
12/31/1944 600 4638 12/31/1944 600 3574 12/31/1944 600 4776
12/31/1945 600 6006 12/31/1945 600 4244 12/31/1945 600 5730
12/31/1946 600 4563 12/31/1946 600 3363 12/31/1946 600 5000
12/31/1947 600 3828 12/31/1947 600 2808 12/31/1947 600 4464
12/31/1948 600 3177 12/31/1948 600 2215 12/31/1948 600 4057
12/31/1949 600 3082 12/31/1949 600 1859 12/31/1949 600 4282
12/31/1950 600 3599 12/31/1950 600 1679 12/31/1950 600 4557
12/31/1951 600 3664 12/31/1951 600 1360 12/31/1951 600 5013
12/31/1952 600 3525 12/31/1952 600 861 12/31/1952 600 5053
12/31/1953 600 2734 12/31/1953 600 237 12/31/1953 600 4405
12/31/1954 600 3621 12/31/1954 261 0 12/31/1954 600 5270
12/31/1955 600 3912 12/31/1955 600 5573
12/31/1956 600 3817 12/31/1956 600 5415
12/31/1957 600 2418 12/31/1957 600 4244
12/31/1958 600 2810 12/31/1958 600 5275
12/31/1959 600 2533 12/31/1959 600 5035
12/31/1960 600 1711 12/31/1960 600 4624
12/31/1961 600 1369 12/31/1961 600 5250
12/31/1962 600 533 12/31/1962 600 4158
12/31/1963 586 0 12/31/1963 600 4224
12/31/1964 600 4171
12/31/1965 600 4247
12/31/1966 600 3715
12/31/1968 600 3939
12/31/1969 600 3078
12/31/1970 600 2254
12/31/1971 600 2048
12/31/1972 600 1776
12/31/1973 600 876
12/31/1974 600 119
12/31/1975 141 0
Eaton Vance Traditional Stock Fund Evergreen Small Co S4 Evergreen Mid Cap Growth S3
Sales Load 5.75% Sales Load 0.00% Sales Load 0.00%
12b-1 Fee 12b-1 Fee 1% 12b-1 Fee 1% 1%
Investment 10000 Investment 10000 Investment 10000
Withdrawal Balance Withdrawal Balance Withdrawal Balance
12/31/1968 9424 12/31/1968 10000 12/31/1968 10000
12/31/1969 600 7572 12/31/1969 600 7384 12/31/1969 600 7384
12/31/1970 600 6841 12/31/1970 600 5202 12/31/1970 600 5202
12/31/1971 600 7169 12/31/1971 600 6363 12/31/1971 600 6363
12/31/1972 600 7601 12/31/1972 600 6603 12/31/1972 600 6603
12/31/1973 600 5696 12/31/1973 600 3409 12/31/1973 600 3409
12/31/1974 600 3257 12/31/1974 600 1434 12/31/1974 600 1434
12/31/1975 600 3357 12/31/1975 600 1366 12/31/1975 600 1366
12/31/1976 600 3275 12/31/1976 600 1175 12/31/1976 600 1175
12/31/1977 600 2454 12/31/1977 600 628 12/31/1977 600 628
12/31/1978 600 1997 12/31/1978 600 125 12/31/1978 600 125
12/31/1979 600 1694 12/31/1979 130 0 12/31/1979 130 0
12/31/1980 600 1440
12/31/1981 600 769
12/31/1982 600 204
12/31/1983 600 0
Franklin Utilities Fund
Sales Load 425.00%
12b-1 Fee 0.13%
Investment 10000
Withdrawal Balance
12/31/1968 9570
12/31/1969 600 7895
12/31/1970 600 8286
12/31/1971 600 7478
12/31/1972 600 7332
12/31/1973 600 4668
12/31/1974 600 3122
12/31/1975 600 3740
12/31/1976 600 4136
12/31/1977 600 3835
12/31/1978 600 3233
12/31/1979 600 2643
12/31/1980 600 2186
12/31/1981 600 1979
12/31/1982 600 1897
12/31/1983 600 1563
12/31/1984 600 1188
12/31/1985 600 792
12/31/1986 600 342
12/31/1987 347 0
Variable Annuity 5% Minimum Guarantee Income Benefit
Unfortunately, the Insurance companies are telling you what you want to hear with these "guaranteed benefits". They are telling you that you can have your cake and eat it too. They guarantee that you can withdraw 5% every year from your Variable Annuity and still have your 100% of your money invested. That is really 6% Systematic Withdrawal in disguise, and we know that fails!
According to Morningstar data, Variable Annuity Stock portfolios charge fees etc. which average 2.11% per year while Stock Mutual Funds charge fees and expenses which average 1.59% per year. You pay an extra .52% (half a percent) for the Variable Annuity portfolio over a comparable Mutual Fund. When you add in the extra fee charged for the 5% withdrawal guarantee, more than 6% is being withdrawn from your account every year! That is a recipe for disaster as the history of Systematic Withdrawal demonstrates.
The average life expectancy for a retiring couple is equivalent to age 92.5 for the older spouse. That is 27.5 years for someone who retired at age 65. Systematic Withdrawal has failed in as little as 9 years. TheInsurance company would have to make up 18.5 years of 5% withdrawals. That is more than 90% of the original investment!
The Insurance companies say that the benefit is guaranteed, but they do not have the money to back up that promise. Typically, an Insurance company has an 8% Surplus. That means, they have $108 of assets for every $100 they owe you. If the market drops more than 8%, your guarantee is wiped out!
Variable Annuities are an excellent product if used corrctly, The income benefit is not a proper use of Variable Annuities.
There is a formal way use your assets to provide your retirement income. Click on the words Retirement Planning at the top of this page for more information.
Target Date Funds, Lifecycle Funds
These names of these Funds imply that your investment will mature in a particular year so that you will have the money you need to retire. It sounds like a "no brainer" just put your money in and relax while you wait for retirement. Those funds have money invested in stocks and bonds, both of which fluctuate with the markets. No portfolio manager can control what the market does to his investment choices. Thus the implied promise that your money will be ready when you retire is nonsense.
According to Morningstar, in March 2009, the average Target Date 2010 fund had lost 25.19% ! Sounds like someone will have to postpone his retirement.
There is a very specific way to target money for the beginning of your retirement. Click on the TAB Retirement Planning at the top of this page for more information.
Pension Max
There is a technique which claims it will increase your retirement income if you retire with an Employer pension. School teachers and other government employees are usually vulnerable to these sales pitches.
With an Employer pensionplan, you ahve to select the form of your benefit payout - either a single life or a Joint & Survivor benefit. Married people take the Joint & Survivor benefit so that the surviving spouse has an income. The single life benefit pays more, and that is very tempting, but it leaves the surviving spouse with no income!
The Pension Max technique has the employee take the Single life benefit, and buy a life insurance policy on the employee's life so that when he dies, the spouse will take the death benefit from the life policy and buy an annuity to replace the lost income. In theory, it sounds great, but it does not work out that way in reality.
The Life Insurance costs money; so some of the excess income from the Single Life benefit is reduced. More important, there is no guarantee of the income that the death benefit will buy. Annuity costs vary with age, interest rates , and mortality.By the tim ethe employee dies, you do not know how much income that death benefit will buy. The wido ends up sufferring in her old age.
Understand the motivation of th salesman. If you take the Joint & Survivor benefit, he has no chance to make a sale, and his commission is zero. If you do Pension Max, he makes 90% of the first year's premium for the Life Insurance, and then he makes another 4% on the Annuity when that is purchased. IT is a good deal for him but not for you.
Click on the words Retirement Planning at the top of this page for more information about the right way to structure your retirement income.
Stretch IRAs
Another bogus "wealth" strategy is called the Stretch IRA,. You take the minimum required distribution from your IRA during your lifetime so that your heirs will inherit what is left and stretch that income over their lifetimes. The projections of cash flow to your heirs can run into the millions. Unfortunately, those projections forget about taxes which have to be paid first before your children inherit anything. Your estate may have to pay estate taxes and your heirs will have to pay inheritance taxes to the state of Pennsylvania.
Where will the tax money come from? The executor of your estate will have to use other assets in order to pay the taxes. Worse yet, if your IRA is basically your only asset, your estate will first have to withdraw some of your IRA money to pay the estate taxes which can run up to 50% if you are wealthy. The estate will then have to pay income taxes on the IRA withdrawal. Estates do not get a standard deduction or personal exemptions, so that every dollar is taxed probably at 25% or more.
Then your heir will have to pay the Pennsylvania inheritance tax which is 4.5%. Where is your heir going to get the 4.5% of his large inheritance? They will probably have to withdraw money from the IRA, and add that amount to their other taxable income for that year and be bumped up into a higher tax bracket for that year just sothat they can pay the inheritance tax.Once all those taxes have been paid, then you can project the future payouts from what is left! All those taxes will lower the projections markedly because they happen before your heirs receive anything. That is more than a slight oversight!
The salesman's motivation is that he hopes your children will let him continue to "manage" the money so that he continues to collect the fees and commissions on your account.
Fear and Greed are Not the Problem - Don't Be Lazy
Every financial advisor will tell you that people make investment mistakes as a result of fear or greed. Either they are afraid to lose money, so they do not take advantage of a good opportunity, and miss out on the profits; or they see the profit potential and ignore the risks which unfortunately turn into real losses.
WE ALL MAKE DECISIONS EMOTIONALLY RATHER THAN RATIONALLY, AND THEN RATIONALIZE THAT DECISION IN ORDER TO JUSTIFY OURSELVES.
The real problem is that we are all lazy! If you are afraid of the risks, understand that everything you do with money involves a risk. Even if you buy your child a lollypop for a dollar now, you may need that dollar later in your retirement. Even if you hide your money under the mattress, you lose buying power due to inflation.
If you are afraid it is because you have not done your homework. There is nothing wrong with choosing not to take a risk. However, you may be taking greater risks by doing something else. Do your homework, learn what you need to know about all the risks, and then you can make an intelligent decision about whether you want to make that investment.
There is nothing with taking advantage of an oppportunity even though there is risk involved. However, If you are thinking that an investment is a sure thing, you have not done your homework. Play the Devil’s advocate. Ask what the risks are, and make sure that you are not reckless in dismissing the risk as “nothing”
Again, it is laziness not fear or greed that causes people to make investment mistakes
WHAT DIVERSIFICATION CAN AND CANNOT DO.
Modern Portfolio Theory was always wrong - You cannot diversify away the risks of investing.
Modern Portfolio Theory suggested that you could eliminate most of the risks of investing by diversifying across many different asset classes - i.e. stocks, bonds, real estate, commodities etc. Diversifying your investments that way increases your chances of growing your assets, but it does not alter the risks which are inherent in those asset classes. If the stock market goes down, your stocks go down! The only way to avoid that result is to get out of the stock market before it declines substantially. Of course, timing the market has nothing to do with diversification.
Modern Portfolio Theory appeared to be true in the 1970s, because only a small segment of the American population invested in the stock and other markets. There were pockets of unexploited opportunity which could be very profitable. Now, in the 21st Century, everybody is an investor. Everybody is looking for a way to get rich. Every investment opportunity is being exploited. Derivatives and other investment opportunities which did not exist 40 years ago are being created just to create new investment opportunities. The result is that there is no place to hide!
Another problem is created by amateur investors who simply “jump on the bandwagon” thinking that if stock already doubled in value, it will double again after they bought it. Those people who did not do their homework overpay for their stocks, and those price levels are not supported by the intrinsic value of owning the company. It is a game of musical chairs, and nobody wants to be the last person holding the bag. The slightest hint of stock market jitters exposes that over priced stock to a sell off.
Some people have used significant leverage (borrowed money) in order to take greater advantage of a rising stock market. When they lose money in the stock market, they often have to sell perfectly good assets of a different kind in order to pay off their loans. That starts a cascading effect because now perfectly good assets are losing money and other people sell those assets in order to avoid even further losses. Again, there is no place to hide! Even if you are happy with your investments, other people are causing the market to behave in a way that hurts you.
Diversification can help you immensely if you use it the right way.
People are afraid to make a mistake. No matter how hard I have tried, I always make some kind of mistake. I have never done anything perfectly. In baseball you get 3 strikes and you are out! In investing, you get as many chances to succeed as you can afford.
When the market is going up, Modern Portfolio Theory was right. You will make more money by diversifying your portfolio over a number of different risks - not asset classes. Every investment you make represents a choice of a “package deal” Every choice that you make is an opportunity for success or failure. Diversification reduces your chances for failure.
Maybe the stock that you chose was the wrong investment because the company was in the wrong line of business, or the company did not have a strong enough position in its market, or maybe the management of the company did not create the right business strategy, or maybe management did not execute their strategy well compared to the competition.
If you are confident that you chose the right line of business, then reduce your risk by selecting several “good” companies in that line of business, so that if your theory is correct, some companies will capture the profits that you expected even if others do not. It does not matter how smart you are, the future price of the stocks that you own is determined by what other people think of those stocks. More important, do they put their money where their mouth is? Do they buy the stock at higher and higher prices?
Obviously, you do not control what other people do. However, you know that they are looking for opportunities just like you are. If one line of business was a promising investment idea, then there must be other lines of business which are also good investment opportunities. Diversify your portfolio amongst several of the most promising lines of business. Now what you have is a stock portfolio that looks like a Mutual Fund. You might as well buy a Mutual Fund and save your self all that work of creating your portfolio.
When you pick a Mutual Fund, you are really picking a portfolio management team. Real people are not perfect and they make mistakes. No one person or team has access to all the best investment research, or has all the best investment ideas, or can visualize the future of every investment opportunity correctly. Why take the risk of picking the wrong investment management team? Pick several of the best performing Mutual Funds. How many Mutual Funds should you pick? Pick all the Funds that you think are going to add to your chances of success. Yes, you will have more paper records to file, but why be lazy.
It is a documented fact that my wife and I liquidated 127 Mutual Fund accounts on or about January 18, 2008 because I determined that the bull market was over. That shows you what I mean by don’t be lazy. We had diversified our assets with Mutual Funds in the following categories:
China, India, Korea, Europe, Russia, Latin America. US Small Cap Growth, Energy, and Natural Resources.
We picked what appeared to be all the best performing categories of the global stock market, and we picked several portfolio management teams who seemed to be doing well in those categories. Some of our picks were outstanding, most were as good as I had hoped, some performed poorly, and a few were losers. We outperformed the average stock Mutual Fund substantially!
If we had stayed in the market, we would have lost money like everyone else. Diversification helps you on the upside, but cannot prevent losses on the down side.
Don’t Do a ROTH conversion
The tax laws have changed, allowing just about anyone to convert a Traditional IRA into a ROTH IRA. The big sales pitch is that, after 5 years, ROTH IRA withdrawals are tax free. That is misleading. They are tax free, but you already paid the income tax on the principal. The only thing which is truly tax free is the investment profits.
For most people, converting a traditional IRA to a ROTH IRA is a bad move. The only way you would benefit from that conversion is if your tax bracket in the future (retirement?) will be higher than it is now. If you are sloppy in calculating your current and future tax bracket, you will come up with the wrong answer!
You need to calculate 2 different income taxes. Use the table provided with your IRS tax forms every year.
BEFORE
Tax on Current Income (Wages etc.) + Traditional IRA balance
AFTER
Tax on projected Retirement Income + (Traditional IRA balance X .06588)
Calculate Difference _AFTER - BEFORE ___________
If difference is positive, do the ROTH conversion.
If the difference is negative, DON’T DO THE ROTH CONVERSION
The .06588 factor represents a 25 year Term Certain annuitization of the IRA balance (i.e. your retirement income stream - a pension)
Do not forget that your Social Security benefits may be taxable depending on your total retirement income, (50% or 85% taxable)
Don’t guess. Do the calculations!
Furthermore, if you are thinking that you will leave this money as a tax free income for your children be aware that, by law, they must take the money annually over their lifetime starting a year from your death, or they must take a lump sum, 5 years after your death. Again, do the BEFORE and AFTER calculations using your beneficiaries’ taxable income data before you assume that the conversion is in your best interest.
There may be other situations in which a ROTH IRA conversion is justified, but the only one I can think of is the business owner who lives on his wages during his working life, and then sells the business. The proceeds from the sale of the business might generate a higher income in retirement for that businessman.
Don’t guess. Do the calculations!
Monte Carlo Analysis is Misleading
There is an analytical technique known as a Monte Carlo analysis. That analysis is very useful when you are working with a process which is statistical in nature i.e. deals with averages and probability etc. Unfortunately, some people like to impress you with a fancy analysis even if it should not be used.
When you retire, some part of the following 40 years will be your retirement. A Monte Carlo analysis would apply your retirement investment strategy to every past 40 year period for which there was data, and it would determine whether that investment strategy succeeded or failed during each of those 40 year periods.
For example, the analysis might conclude that your intended retirement investment strategy worked 86% of the time! That sounds like a winning strategy because it has an 86% chance of succeeding. WRONG! Your strategy has a 14% chance of failing! Out of one hundred 40 year periods, your investment strategy would fail to provide you the income you need to pay your bills 14 times! You would be dead broke berore you were dead.
Your retirement is some part of the 40 years following your date of retirement. You do not get to choose which 40 year period that is. You get what you get during those 40 years! If your 40 year period leads to failure, you cannot pay your bills and you starve to death!
Click on the Retirement Planning Tab above to learn the correct way to provide your income in retirement.