Roughly thirty years ago, we started a new experiment in qualified plans, such as 401k and IRA. Now that the time is nearing for the baby boomers to rely on these plans for their retirement, the cracks in the system are appearing. When individuals start a qualified plan, they hope to see the balance increase, and reach their dream of retirement. Unfortunately, these retirement plans rarely become reality.
Countless families are not able to support themselves on these retirement plans, with nothing to fall back on. However, there is a solution. Just by making small changes in how you approach wealth management, you’ll have a retirement that you and your family can live well on.
Let’s start with a simple example—let’s say the owner of this retirement account needs to buy a car. Where are they going to get the money to finance the car?
Most people are taught to finance a new car one of three ways: first is a bank loan, second is leasing, and lastly (what most of us have been taught is the best) is to pay cash. This is where we begin to see the flaws in traditional financial planning. Whether or not we used a bank loan or cash for the purchase, you still financed the car. You are forced to make a decision between building your retirement or financing other life necessities.
It doesn’t have to be this way—you can build your retirement, while still having all the things you need in life. This is known as “becoming your own banker” and it’s actually a fairly simple idea.
Let’s look at a little known financial principle: you finance everything you purchase, whether you get a loan or pay cash. I understand this is contrary to what we’ve been taught, but let’s look at this for a moment. If you go to the bank and ask for the money upon approval they will give you the money and make you sign the agreement with the terms of the loan—I never had anyone argue with me on that definition of financing. I do have people argue, when I say you have financed a car even though you’ve paid cash. However, remember that you finance everything you buy and here is why: you either pay interest or give up the ability to earn interest.
It’s just like when you borrowed the money from the bank to purchase the car, in order to get the pink slip. You have to give your money to the institution, thereby losing the ability to ever earn interest on the money in the future, as well as the ability to ever use that money again for future needs. This is called opportunity cost, which is what the money would have been worth at some future date had you been able to invest it.
I’ve often been asked–how bad could it really be? How much interest could we really be losing? So let’s assume a family has just purchased a new $56,000 SUV, and the idea was to use it for 10 years before purchasing a new vehicle. The couple is in their mid 30’s, and they paid cash for the SUV. Now most of these cars today are financed over 72-84 month terms, so we will assume they refilled their savings account the same way over the next seven years.
This couple easily has 50-60 years of life left in them, so we will need to look at what the lost interest would be over their lifetime assuming they only bought one of these SUV’s. The assumption will be that they were able to earn just 4% on that money had they been able to invest it.
Here are the numbers: had they invested the $56,000 today and earned the 4% compounding over the next 60 years it would have grown to $589,099 but starting that compounding growth just 7 years later the account grew to just $447,667. The loss in interest growth alone was over $141,000! Did you ever think one car would cost you that much more than what you paid?
Remember that so far we have only been talking about the lost opportunity cost of the interest. Problem is we need to address the loss of the principal as well—the $56,000 they used to pay for the SUV.
Since most readers probably aren’t looking to spend $56k on a car, let’s talk about $20,000 cars instead, and assume the car will be owned over a ten-year period of time. Since they are a married couple, we can assume there will be two vehicles making for one car purchase every five years. I think most people can relate to something like that. We will still assume 4% rate of return on all dollars saved, the family saves $4,000 per year to make the next car purchase and they will be replacing one car every five years resetting the growth of that savings every time they buy a new car.
Get ready for some numbers that may make you a little ill: if this couple would have been able to put that $4,000 a year into an account for 60 years without ever having to empty the account when they bought each car it would have grown to $994,041 but because they took the money out every five years to pay cash for each car they were left with only $26,532.
How do you feel when you look at those numbers? Remember that you finance everything you buy, you either pay interest or you give up the ability to earn interest. Regardless of using a bank loan or paying cash you are separating yourself from your money and losing the opportunity of future use and growth.
By making small changes to your finances and becoming your own banker you can recoup the cost of every future car purchase for the rest of your life. In short, you are creating wealth from the money you are spending anyway. Imagine what could happen if over time we were able to include your house and other purchases.
If you recall, at the beginning of this piece I was talking about retirement accounts and qualified plans. I mentioned there may be a few flaws. How many qualified plans do you know of that will allow for you to build your retirement account by financing the purchases you will have throughout your life? Not to mention, how many people do you know with qualified plans, that even come close to breaking the million dollar mark? If what you thought to be true turned out not to be true when would you want to know about it?
There are hundreds of different ways you can protect yourself in the future, for a better retirement. By contacting wealth managers, you can learn ways to grow your retirement that best suit your needs.
Call us today for a free consultation.