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Saving for Retirement May 20, 2008

Posted by shaferfinancial in Uncategorized.
Tags: , , , , ,

If there is one place that there is much misinformation, it is in how much you need to save for retirement.  The mutual fund industry has spent much time and effort to propagandize to folks why they can accomplish this using mutual funds.  The truth is much different.  Now there is one caveat before I go into the numbers.  If you are fortunate to have a defined benefit pension, then you can make it work by putting monthly money aside into a mutual fund inside a IRA/401K wrapper.  Even better if you also qualify for social security.  But, if you really want to accumulate enough to have a comfortable retirement then pay attention.  If you don’t have a defined benefit pension, then it is critical that you understand the following.

Mutual funds have been sold as a safe/low risk investment.  And that is truthful.  But the rule of finance is that the lower the risk the lower the potential rate of return.  Now we know that individuals that purchase mutual funds average 2.5%-4% rate of return.  But for the point of this exercise lets assume a 8% rate of return (the average mutual fund return).

Now here is my rule of thumb.  In order to build enough wealth to have a comfortable retirement you must get 15% rate of return from you investments.  Let me show you why.

Lets say you put away $300/month until your retirement in 25 years.  Let’s also assume you never fail to put this money away.  If you get a 8% return on investment, you would have $285,308 after those 25 years.  This can produce $22,800 of taxable income per year assuming that same 8%.  Not bad.  That puts you in the top quarter of net worth for folks in the United States.  However, you haven’t accounted for inflation. Taking official inflation statistics, which I believe seriously understates inflation, that $285,308 has the buying power of $142,654 or $11,400 year.  But that is on day one of retirement.  The average person will live another 20-25 years.  So by the time you die that $285,308 will only have $71,327 of buying power or $5,700/year.

Now let’s run the numbers with 15%.  Same deal, $300/month for 25 years.  Now you have $973,059 and using 8% of it each year you would have $77,844/year.  But the buying power would only be $38,922 when you retire and $19,461 at likely death.

Now that is more like it!  But you say how can I get 15% without risk?  You can’t.  But you can get 15% assuming less but a different type of risk than you have with mutual funds. 

First, can you spot the risk of investing in mutual funds?  Well it is the very real risk of running out of money before you die.  In fact, 90% of retired folks are financially dependant on the government or family/friends before they die.  Remember mutual funds have been sold to the public for 2 generations and that strategy has been pushed for just as long.  So that risk is extremely high.

Here is the less risky way.

1. Find a stock that has returned over 15% for over 40 years.

2. Use leverage.  If you leverage an investment three to one you only have to have that asset return 5% to get that 15% return.

For regular readers you now should know the answers.  There is only one stock that has returned over 15% for 40+ years.  Berkshire Hathaway.  In fact it has returned over 21% for 43 years.  Over 18% for the last 10 years. I put my bet on Warren Buffett the driving force behind Berkshire Hathaway.

Finally, investment real estate, properly structured in growth areas have historically returned over 6%.  You can leverage this with mortgages.  And you get all the tax advantages of real estate.

Your choice on the risk.  Bet on two things that have proven to give superior returns over the last two generations, or bet on mutual funds which have proven to given inferior returns over the last two generations.


       ***** As always, this post in only the musings of a clearly deranged individual that happens to be good at math.  He has no license to sell securities nor real estate and any advice should be considered for amusement purposes, not expert advice that ones gets from a licensed individual.**** 


1. BawldGuy Talking - May 21, 2008

It’s the 20-something crowd who will do well digesting this advice. Imagine hitting 35-40 years old and having the option of working by choice.

It’s absolutely on their menus if they pay attention.

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