August 27, 2008

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The OTHER Millionaire You Make


by David B. Loeper, CIMA®, CIMC®


"...And the man in the suit has just bought a new car
from the profit he's made on your dreams."
- Steve Winwood and Jim Capaldi

We all know the financial services industry provides us with a myriad of choices in our quest to invest and grow wealth as a means to achieving our valued financial goals. In exchange for performing this role, in 2006, gross revenues for the financial services industry were nearly $1.1 trillion. (We are excluding real estate from the calculation to focus on banking, brokerage and insurance and exclude home ownership and direct real estate investing which would more than double the figure.) Total US financial assets stood at $44 trillion in 2007, meaning that the financial services industry as a whole is skimming 2.5% a year out of everyone’s wealth. If you think about this, the cost of these "services" is staggering. How can it cost us as a nation on the order of $1.1 TRILLION just to manage and service our wealth?

Let's look at an example. Say you and your spouse are twenty-five years old. You are a teacher and your spouse is a police officer. Your combined incomes are $75,000. Things are tight, but your parents taught you the value of compounding, saving for a rainy day, and retirement. Both of you have retirement plans through your employers with matching contributions and despite the compromise to your lifestyle, together you defer $5,000 a year to your retirement plans. This is a little less than 7% of your income; far below what many advisors and financial gurus would advise with their common rules of thumb. Your employers match some of your contributions, which add another $2,000 a year to your retirement savings, bringing your total annual retirement savings to $7,000 a year. Since both are working for the government, your jobs are fairly secure and your incomes will likely adjust for inflation each year along with your savings and matching employer contributions.

The good news is that after forty years of compromising lifestyle choices to make these savings a priority, at a 7.5% return you and your spouse together would have accumulated almost $2.5 million! (The bad news is the effects of inflation are likely to leave that $2.5 million with a spending power of only about $760,000 in today's dollars; but it is still an impressive nest egg for a middle income family.)

But what about the financial services industry? What did THEY make on your forty years of compromises to your lifestyle? You accumulated $2.5 million through diligent savings, and if your fees were 2.5% – as the entire drag of financial services is on the entire wealth of the country – THEY would have made more than $1.7 MILLION on YOUR wealth!!! (See Exhibit I). Does it make sense for the product vendors to accumulate 68% of what YOU accumulate? They are not the ones compromising their lifestyle for forty years or taking the investment risks. And, even at a more reasonable 1.5% fee, you and your spouse would still make them a millionaire (see Exhibit II). No wonder the financial services industry is such a large part of our economy.

Think about the impact to your life an extra $1,700,000 or $1,000,000 would make in retirement. And, keep in mind that in this example we are not talking about super wealthy executives, we are talking about a school teacher and policeman diligently making fairly modest savings over a life long career.

Why does our example couple, and why do we as consumers of financial services, allow ourselves to be used in this fashion, contrary to our best interests? The financial services industry is unique among all others. Most people are not fooled by infomercial charlatans (many are though). They skeptically avoid magic diet pills that come and go with scientific sounding names and “double blind studies" supposedly backing up their fantastic claims. They avoid miracle products not available in stores or free limited time offers (that only require a “small" shipping and handling charge). But much of the financial services industry is not really any different. Somehow, the financial services industry has been able to evade being painted with the same brush other bogus products and services have and in most cases they have been able to cast their sales spin and outrageous claims in a very different light. Somehow (through effective marketing), they have created a world where the impression in people's minds is bifurcated. The financial services industry simultaneously has created an impression in people's minds of being sophisticated, smart, and polished while at the same time (often more in one's subconscious) the industry is known to be scandalous and justifiably worthy of a very high level of skepticism because deep down we know that we are being sold.

The stakes to your lifestyle are too high to permit yourself to become a victim of well-packaged marketing spin or highly polished sales pitch. Your wealth is the product of your entire life's productive labor. The profound importance of what your accumulated wealth really represents is a lifetime of compromises, hard work, missed little league games and recitals. It is the result of seeing the tears in your daughter's eyes when the critical business trip you took caused you to miss seeing her perform in the school pageant. Your wealth is the result of coping with your son's anger for missing seeing him pitch his only no hitter when you had to work overtime. This is not something that should be treated in a cavalier manner. It shouldn't be based on fiction and coercion through sales spin and product packaging. Your wealth should not be skimmed to make millionaires out of aggressive, conflicted sales people at the expense of your lifestyle. Seeing those tears, or hearing and feeling that anger, is a huge price to pay and it should not be dominated by misleading or false marketing that victimizes customers based on ill founded hopes packaged in a convincing (yet bogus) brochure, advertisement, book or “research" report that only tells half of the story.

Yet, throughout financial services and many areas that are not directly considered financial services, the focus is on the sale and spin, not on facts, reality or even disclosure. There are a handful of exceptions to this of course, but the typical consumer or even experienced financial advisor for that matter, often cannot discern the difference. In our next installment, we will discuss the question why investors – and some financial advisors – allow themselves to be sold and what you can do about it.





Exhibit I
Two 25 Year Olds, Each Saving $2,500 w/ $1,000 match Product Vendor Investing Their 2.5% Excess Fees
Year 401k Contribution Including Match Starting Value Investment Return of 7.5% Ending Value Excess Fees of 2.5% Starting Value Investment Return of 7.5% Ending Value
1 $ 7,000 $ 7,000 $ 525 $ 7,525 $ 188 $ 188 $ 14 $ 202
2 $ 7,210 $ 14,735 $ 1,105 $ 15,840 $ 396 $ 598 $ 45 $ 643
3 $ 7,426 $ 23,266 $ 1,745 $ 25,011 $ 625 $ 1,268 $ 95 $ 1,364
4 $ 7,649 $ 32,660 $ 2,450 $ 35,110 $ 878 $ 2,241 $ 168 $ 2,409
5 $ 7,879 $ 42,989 $ 3,224 $ 46,213 $ 1,155 $ 3,565 $ 267 $ 3,832
6 $ 8,115 $ 54,328 $ 4,075 $ 58,402 $ 1,460 $ 5,292 $ 397 $ 5,689
7 $ 8,358 $ 66,761 $ 5,007 $ 71,768 $ 1,794 $ 7,483 $ 561 $ 8,044
8 $ 8,609 $ 80,377 $ 6,028 $ 86,405 $ 2,160 $ 10,205 $ 765 $ 10,970
9 $ 8,867 $ 95,272 $ 7,145 $ 102,418 $ 2,560 $ 13,530 $ 1,015 $ 14,545
10 $ 9,133 $ 111,551 $ 8,366 $ 119,918 $ 2,998 $ 17,543 $ 1,316 $ 18,859
11 $ 9,407 $ 129,325 $ 9,699 $ 139,024 $ 3,476 $ 22,334 $ 1,675 $ 24,009
12 $ 9,690 $ 148,714 $ 11,154 $ 159,868 $ 3,997 $ 28,006 $ 2,100 $ 30,107
13 $ 9,980 $ 169,848 $ 12,739 $ 182,586 $ 4,565 $ 34,671 $ 2,600 $ 37,272
14 $ 10,280 $ 192,866 $ 14,465 $ 207,331 $ 5,183 $ 42,455 $ 3,184 $ 45,639
15 $ 10,588 $ 217,919 $ 16,344 $ 234,263 $ 5,857 $ 51,496 $ 3,862 $ 55,358
16 $ 10,906 $ 245,169 $ 18,388 $ 263,557 $ 6,589 $ 61,947 $ 4,646 $ 66,593
17 $ 11,233 $ 274,790 $ 20,609 $ 295,399 $ 7,385 $ 73,978 $ 5,548 $ 79,526
18 $ 11,570 $ 306,969 $ 23,023 $ 329,991 $ 8,250 $ 87,776 $ 6,583 $ 94,359
19 $ 11,917 $ 341,909 $ 25,643 $ 367,552 $ 9,189 $ 103,548 $ 7,766 $ 111,314
20 $ 12,275 $ 379,826 $ 28,487 $ 408,313 $ 10,208 $ 121,522 $ 9,114 $ 130,636
21 $ 12,643 $ 420,956 $ 31,572 $ 452,528 $ 11,313 $ 141,949 $ 10,646 $ 152,595
22 $ 13,022 $ 465,550 $ 34,916 $ 500,466 $ 12,512 $ 165,107 $ 12,383 $ 177,490
23 $ 13,413 $ 513,879 $ 38,541 $ 552,420 $ 13,810 $ 191,300 $ 14,348 $ 205,648
24 $ 13,815 $ 566,235 $ 42,468 $ 608,702 $ 15,218 $ 220,865 $ 16,565 $ 237,430
25 $ 14,230 $ 622,932 $ 46,720 $ 669,652 $ 16,741 $ 254,172 $ 19,063 $ 273,234
26 $ 14,656 $ 684,308 $ 51,323 $ 735,631 $ 18,391 $ 291,625 $ 21,872 $ 313,497
27 $ 15,096 $ 750,727 $ 56,305 $ 807,032 $ 20,176 $ 333,673 $ 25,025 $ 358,698
28 $ 15,549 $ 822,581 $ 61,694 $ 884,275 $ 22,107 $ 380,805 $ 28,560 $ 409,366
29 $ 16,015 $ 900,290 $ 67,522 $ 967,812 $ 24,195 $ 433,561 $ 32,517 $ 466,078
30 $ 16,496 $ 984,308 $ 73,823 $ 1,058,131 $ 26,453 $ 492,531 $ 36,940 $ 529,471
31 $ 16,991 $ 1,075,122 $ 80,634 $ 1,155,756 $ 28,894 $ 558,365 $ 41,877 $ 600,242
32 $ 17,501 $ 1,173,256 $ 87,994 $ 1,261,251 $ 31,531 $ 631,774 $ 47,383 $ 679,157
33 $ 18,026 $ 1,279,276 $ 95,946 $ 1,375,222 $ 34,381 $ 713,537 $ 53,515 $ 767,053
34 $ 18,566 $ 1,393,788 $ 104,534 $ 1,498,322 $ 37,458 $ 804,511 $ 60,338 $ 864,849
35 $ 19,123 $ 1,517,446 $ 113,808 $ 1,631,254 $ 40,781 $ 905,630 $ 67,922 $ 973,553
36 $ 19,697 $ 1,650,951 $ 123,821 $ 1,774,772 $ 44,369 $ 1,017,922 $ 76,344 $ 1,094,266
37 $ 20,288 $ 1,795,060 $ 134,630 $ 1,929,690 $ 48,242 $ 1,142,508 $ 85,688 $ 1,228,196
38 $ 20,897 $ 1,950,587 $ 146,294 $ 2,096,881 $ 52,422 $ 1,280,618 $ 96,046 $ 1,376,665
39 $ 21,523 $ 2,118,404 $ 158,880 $ 2,277,284 $ 56,932 $ 1,433,597 $ 107,520 $ 1,541,117
40 $ 22,169 $ 2,299,454 $ 172,459 $ 2,471,913 $ 61,798 $ 1,602,914 $ 120,219 $ 1,723,133
Exhibit II
Two 25 Year Olds, Each Saving $2,500 w/ $1,000 match Product Vendor Investing Their 1.5% Excess Fees
$ 0 $ 0
Year 401k Contribution Including Match Starting Value Investment Return of 7.5% Ending Value Excess Fees of 1.5% Starting Value Investment Return of 7.5% Ending Value
1 $ 7,000 $ 7,000 $ 525 $ 7,525 $ 113 $ 113 $ 8 $ 121
2 $ 7,210 $ 14,735 $ 1,105 $ 15,840 $ 238 $ 359 $ 27 $ 386
3 $ 7,426 $ 23,266 $ 1,745 $ 25,011 $ 375 $ 761 $ 57 $ 818
4 $ 7,649 $ 32,660 $ 2,450 $ 35,110 $ 527 $ 1,345 $ 101 $ 1,446
5 $ 7,879 $ 42,989 $ 3,224 $ 46,213 $ 693 $ 2,139 $ 160 $ 2,299
6 $ 8,115 $ 54,328 $ 4,075 $ 58,402 $ 876 $ 3,175 $ 238 $ 3,413
7 $ 8,358 $ 66,761 $ 5,007 $ 71,768 $ 1,077 $ 4,490 $ 337 $ 4,827
8 $ 8,609 $ 80,377 $ 6,028 $ 86,405 $ 1,296 $ 6,123 $ 459 $ 6,582
9 $ 8,867 $ 95,272 $ 7,145 $ 102,418 $ 1,536 $ 8,118 $ 609 $ 8,727
10 $ 9,133 $ 111,551 $ 8,366 $ 119,918 $ 1,799 $ 10,526 $ 789 $ 11,315
11 $ 9,407 $ 129,325 $ 9,699 $ 139,024 $ 2,085 $ 13,401 $ 1,005 $ 14,406
12 $ 9,690 $ 148,714 $ 11,154 $ 159,868 $ 2,398 $ 16,804 $ 1,260 $ 18,064
13 $ 9,980 $ 169,848 $ 12,739 $ 182,586 $ 2,739 $ 20,803 $ 1,560 $ 22,363
14 $ 10,280 $ 192,866 $ 14,465 $ 207,331 $ 3,110 $ 25,473 $ 1,910 $ 27,383
15 $ 10,588 $ 217,919 $ 16,344 $ 234,263 $ 3,514 $ 30,897 $ 2,317 $ 33,215
16 $ 10,906 $ 245,169 $ 18,388 $ 263,557 $ 3,953 $ 37,168 $ 2,788 $ 39,956
17 $ 11,233 $ 274,790 $ 20,609 $ 295,399 $ 4,431 $ 44,387 $ 3,329 $ 47,716
18 $ 11,570 $ 306,969 $ 23,023 $ 329,991 $ 4,950 $ 52,665 $ 3,950 $ 56,615
19 $ 11,917 $ 341,909 $ 25,643 $ 367,552 $ 5,513 $ 62,129 $ 4,660 $ 66,788
20 $ 12,275 $ 379,826 $ 28,487 $ 408,313 $ 6,125 $ 72,913 $ 5,468 $ 78,381
21 $ 12,643 $ 420,956 $ 31,572 $ 452,528 $ 6,788 $ 85,169 $ 6,388 $ 91,557
22 $ 13,022 $ 465,550 $ 34,916 $ 500,466 $ 7,507 $ 99,064 $ 7,430 $ 106,494
23 $ 13,413 $ 513,879 $ 38,541 $ 552,420 $ 8,286 $ 114,780 $ 8,609 $ 123,389
24 $ 13,815 $ 566,235 $ 42,468 $ 608,702 $ 9,131 $ 132,519 $ 9,939 $ 142,458
25 $ 14,230 $ 622,932 $ 46,720 $ 669,652 $ 10,045 $ 152,503 $ 11,438 $ 163,941
26 $ 14,656 $ 684,308 $ 51,323 $ 735,631 $ 11,034 $ 174,975 $ 13,123 $ 188,098
27 $ 15,096 $ 750,727 $ 56,305 $ 807,032 $ 12,105 $ 200,204 $ 15,015 $ 215,219
28 $ 15,549 $ 822,581 $ 61,694 $ 884,275 $ 13,264 $ 228,483 $ 17,136 $ 245,619
29 $ 16,015 $ 900,290 $ 67,522 $ 967,812 $ 14,517 $ 260,137 $ 19,510 $ 279,647
30 $ 16,496 $ 984,308 $ 73,823 $ 1,058,131 $ 15,872 $ 295,519 $ 22,164 $ 317,683
31* $ 16,991 $ 1,075,122 $ 80,634 $ 1,155,756 $ 17,336 $ 335,019 $ 25,126 $ 360,145
32 $ 17,501 $ 1,173,256 $ 87,994 $ 1,261,251 $ 18,919 $ 379,064 $ 28,430 $ 407,494
33 $ 18,026 $ 1,279,276 $ 95,946 $ 1,375,222 $ 20,628 $ 428,122 $ 32,109 $ 460,232
34 $ 18,566 $ 1,393,788 $ 104,534 $ 1,498,322 $ 22,475 $ 482,706 $ 36,203 $ 518,909
35 $ 19,123 $ 1,517,446 $ 113,808 $ 1,631,254 $ 24,469 $ 543,378 $ 40,753 $ 584,132
36 $ 19,697 $ 1,650,951 $ 123,821 $ 1,774,772 $ 26,622 $ 610,753 $ 45,806 $ 656,560
37 $ 20,288 $ 1,795,060 $ 134,630 $ 1,929,690 $ 28,945 $ 685,505 $ 51,413 $ 736,918
38 $ 20,897 $ 1,950,587 $ 146,294 $ 2,096,881 $ 31,453 $ 768,371 $ 57,628 $ 825,999
39 $ 21,523 $ 2,118,404 $ 158,880 $ 2,277,284 $ 34,159 $ 860,158 $ 64,512 $ 924,670
40 $ 22,169 $ 2,299,454 $ 172,459 $ 2,471,913 $ 37,079 $ 961,749 $ 72,131 $ 1,033,880
*Notice the excess fees actually exceed the entire contribution amount
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The OTHER Millionaire You Make
August 27, 2008 © Wealthcare Capital Management. All Rights Reserved


 

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