Stock-Market Based Retirements: The Big Lie

When approaching a stock broker for investing, he will inevitably offer two warnings regarding your investment; 1) Don’t invest it unless you can stand to lose it, and 2) If you are going to invest it, you must be in it for the long haul (or long-term).  If these are the two universally-accepted caveats of stock market investing, then why are vast majority of retirement funds riding on (and directly affected by) the stock market?

If I can’t afford to lose my 401K, IRA, or SEP or other retirement account, then why are they stock market based?  If I am in retirement pulling money out of my fund on which to live, then I can no longer be in the stock market for the long term, because any decline affects me NOW; and the funds I am dispersing for living expenses cannot participate in the rebound.  Kinda crazy, huh?  But don’t worry, I haven’t even arrived at the Big Lie yet.

When your stock broker (or financial planner for that matter) sells you on the concept of putting your money on the stock market (after disclosing the two above caveats), he will say, “Based on the 50-year history you can pretty much be assured that that you will average 7.9% per year, as that is the 50-year average of the S&P”.  True:  That IS the 50-year average of the S&P.  Lie:  You’re money does not average what the “index percentage” averages.  It’s a far different story.  Let’s do the math…

If you have $100,000 in a 401K, and the recession of 2001 cuts that retirement account by 50%, you are then down to $50,000.  To get back up to the original balance of $100,000, your 401K must grow by 100% (or double your money), just to make up that 50% loss.  In the financial industry, we use the Rule of 72 to calculate how much time it requires to “double” your money.  To do this, we divide 72 by the percentage of interest.  If your 401K is on the S&P 500 (with a 50-year average of nearly 8%), we divide 72 by 8, which is 9.  This “9” represents the number of years it will take to “double your money”.

In other words, when your retirement account is cut in half (which has happened twice in a seven year period), it typically requires two periods of nine years to regain the losses.  I call this the Loss and Rebound Cycle.

From 1997 to 2010 the average percentage rate of the S&P 500 fell to 7.6% because of two severe recessions during that period of time.  However, because of the Loss and Rebound Cycles, the money riding on that index only averaged 1.1% per year through this same period.

Moreover, as these retirement accounts are taxable, the government “qualified or pre-tax” accounts are a losing prospect for retirement, and all Americans employing these vehicles as their main source of retirement should expeditiously re-think their strategy.

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