Who is Taking a Bite Out of Your Retirement Account?
Don't Watch Your Retirement Account Savings Melt Away Like an Ice Cream on a Hot Day!
Our family has a vacation rule that our daughter loves: Unlimited ice cream! As we ventured toward Magic Kingdom, she was thrilled and looking forward to their special Mickey Ice Cream Bars. As you can see in the picture, she was happily indulging in her treat, completely oblivious to a turn of events that would soon cause her smile to turn to tears of frustration. Can you guess how much of the bar she actually ended up eating? I’ll give you a hint: Daddy wasn’t the main offender!
First, it didn’t take long for the melting to start. It began dribbling down her hands and even her arms. Then a big chunk of chocolate fell to her shirt and hit the ground. And, of course you can see that Daddy snuck in for a bite. It even took two of us to divert a worse disaster, because she nearly dropped the whole thing on the ground and lost it all. As it was, she probably actually ate half of it with most all over her face, hands and clothes. She was absolutely a hot mess. I had an emergency clean-up job with wet wipes.
Naturally this got me thinking how similar this is with retirement accounts. People are often happy with their earned savings as they head into retirement. But all too often they see their nest egg eroded by three culprits: taxes, inflation and fees. In addition, many are at risk from a market drop, which could have a huge impact on the value of their portfolio, and subsequently their retirement income.
When I look back at the experience of my daughter with her ice cream, it’s similar to what I try to protect my clients from.
I see the melting of the ice cream that is like inflation that slowly eats away at the purchasing power of retirement income.
Then you have the big parts of the ice cream that inevitably fall to the ground. When you see chunks disappear, it reminds me of the impact taxes can have on a portfolio.
On top of that, you might have others getting a taste and that reminds me of investment fees. Just like my daughter in the picture, many people don’t even realize these bites that are taken out. Blissfully unaware, they may discover nibbles or even big bites are eating at the performance of their retirement accounts.
Finally, we are always holding our breath, wondering if the ice cream will be dropped to the ground, and of course that relates perfectly to investment risk in the event of a large market drop without proper diversification.
So, how much are these bandits raiding from your retirement accounts? Let’s look at a few simple scenarios on how these might affect a $500,000 retirement account over a 20 year period. For each of the following scenarios, for simplicity sake, we’ll take taxes out of the equation.
As a barometer point, let’s start with a simple CD account, which has does not have market risk or fees. However, the growth is limited and subject to high inflationary risk. We’ll use a 2% annual return for this scenario, which is much higher than the current average rates. We’ll also use the last 20 years inflation for this illustration.
Here we can see the inflation adjusted return. As you can see, inflation is greater than the return, diminishing the account value. Based upon these figures, after 20 years, you could expect to see an actual purchasing power loss on the account! That’s even after the interest of over $257,000.
Now, let’s look at a market-based account that will typically have better growth potential, but will also have market risk. For this illustration, we’ll assume this hypothetical investment matched the S&P 500 historic returns of 10%. Once again, we’re calculating using the last 20 years of inflation, which are relatively low and stable.
You can see the projected outcome with this scenario is much stronger, with a projected portfolio gain of over $1,870,000 in today’s purchasing power!
Typically market based accounts will have investment fees not portrayed in this illustration. However, the increased gains in this comparison scenario should easily cover any investment fees and should still outperform a CD.
Naturally, we want as much growth as possible and unnecessarily high or unjustified fees can impact growth. Here’s a very simple comparison of the impact of fees on an account over 20 years with a projected growth rate of 10%. Here we have scenarios comparing annual investment fees of 4.5%, 2.5% and 1.7%.
This hypothetical scenario doesn’t adjust down to account for inflation. It also doesn’t illustrate differences in returns or risk based upon investment strategies. This may or may not justify variations in investment fees.
A badly timed market drop could cause returns to fall far below these projections. Also, not all investment portfolios are created equal in growth potential, fees or risk.
Finally, let’s look at the x-factor when comparing investment strategies. Taxes. We all know that this can have a huge impact on an investment portfolio’s net return. Taxation should be a consideration when analyzing growth, distribution and estate transfers. Although qualified retirement accounts grow tax-deferred, that doesn’t mean that tax strategies aren’t critical. As a tax advisor, this is an area that I often see overlooked by other investment professionals. Just one example that I often see is poorly strategized Roth IRA Conversions! All facets of a financial plan should be analyzed closely because a poorly planned tax strategy can be costly in both retirement income as well as the estate left to heirs.
We all want lower taxes, lower fees, lower risk, and higher returns, right? Also, you’d probably like to lower your tax burden on those returns. Isn’t it just important to have peace of mind? How about a retirement plan that provides an income stream that won’t run out in retirement? What about being able to leave as much as possible for your family or a cause in which you believe?
One of my primary responsibilities to my clients is to provide investment solutions that meet their goals. Not only do I strive to help them achieve their goals, but I go the extra step in seeking overall solutions that help manager their risk and improve their likelihood of success. I also want to help minimize unjustified investment fees.
We’re probably always going to have taxes, inflation and market risk associated with growth. In addition, financial professionals will always be compensated for their services.
However, I believe that every investment professional should be able to justify the investment fees charged by providing value that outweighs the expense. At McBeath Financial Group, any fees are transparent in the amount and they are fully explained. We also strive to ensure that fees are strategic nibbles that meet the end goal of reducing losses due to inflation or taxes. Furthermore, if the fees invested end up helping to prevent a market fluctuation disaster, you may possibly enjoy more of the money you worked so hard for!
Really, as a mom and an investment advisor it’s my job to ensure less of the Mickey pop melts and hits the ground. That might mean there are fees (or strategic licks of the ice cream) toward the overall end goal of enjoying more of what they’ve earned. After all, no-one benefits from a (melted) mess that ends up everywhere but where intended. And at the end of the day, if everyone is smiling and enjoying more of their dessert, isn’t that the important thing?