As the crow flies – don’t oversimplify your retirement planning

  • September 21, 2015

Originally published in the News Star on Sunday, September 20, 2015.

QUESTION: I’ve done a basic calculation of what I have now and what I save each month. I know what we spend and it looks like we’re going to be OK if I keep this up for another 20 years. I am in my forties. Am I leaving anything major out of my thought process?

ANSWER: Have you ever asked someone for directions and have them replay, “Oh, that’s about a mile away…as the crow flies.”

crow-434755_1280That’s what you might call accurate information that is of little use. If you haven’t looked lately, you’re not a crow and you probably do not intend to fly from point A to point B.

No, you intend to walk, ride or drive from here to there. So you need to know where the streets or trails are that lead you there. And if there are any significant obstacles: traffic jams, bridges out, water covering the road or a parade taking place.

It’s one thing to know the distance assuming no obstacles. It’s quite another thing to understand the distance and the obstacles, so you can estimate the time lost due to those various obstacles.

Let’s assume you did your calculation and started off with $100,000 (you said you are in your mid-40s, so I hope that’s around what you have saved). And you can save $10,000 per year. If you earn 8%, by the time you reach age 65, you’ll have nearly $1,000,000.

At least, that’s what the math says you’ll have – as the crow flies.

But if you have to make that journey in the real world – not soaring above and over all the obstacles like crows are able to do – you’re going to encounter some obstacles. Here are a few:

Taxes. In a regular investment account, each year that your account values grow, you’ll owe taxes on that growth. The exact amount of the tax liability will vary, depending how the account is managed. You may find yourself paying taxes on interest earned, dividends received and capital gains realized. That subtraction would be significant enough, but it’s even worse when you add the volatility of financial markets.

Market fluctuation. A common calculation error is to assume a static tax rate (of say 20%), as well as a static growth rate. We already assumed 8%, remember? Yeah, well that was a mistake – here’s why. Have you ever had a year where your investments grew at the same rate as they did the previous year and your tax liability was the same as it was the year before? Me neither. Well, if that doesn’t ever happen over two years, it sure isn’t likely to happen for 20 years in a row.

So what? The irregular nature of investment returns means that you will sometimes be called on to withdraw money from your account to pay taxes at just the wrong time (when the account is down in value). When you take money out of an investment account to pay the taxes you owe, you remove money that can never again grow. You lock in your losses when you do that, magnifying and making more permanent market down drafts.

Inflation. Inflation means that future dollars won’t buy as much as today’s dollars will. As counterintuitive as it seems, an inflation rate of just 3% per year inflicts more economic damage to your portfolio than a 30% income tax rate per year. If you plan to save towards retirement for the next 20 years, count on just 3% inflation to cut the purchasing power of your future dollars in half.

Human nature. If you thought tax-hungry governments, crazy markets or poor economic policies could hammer your portfolio, here’s another truth: few things consistently sabotage a financial plan more than poorly timed, emotionally reactive decisions…by human beings. Markets fall, so we sell, when we should buy. Insurance has a premium cost, so we focus on price, not realizing the discount life preserver we are acquiring won’t keep us afloat in a storm. We delay saving for “one-last-vacation.”

So, you ask, is there anything you are leaving out? Yeah, I guess there is – it’s all the trees, stumps, road closings and detours down here on the ground that you’ll have to navigate on your way towards financial independence.

Your best tool for deciding which direction to go to avoid the most problems is a map and a guide, also known as a financial plan that comes with a financial planner attached.

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Byron R. Moore, CFP® is Managing Director / Planning Group of Argent Advisors, Inc. Email him at bmoore@argentadvisors.com. Write to him at 500 East Reynolds Drive, Ruston, LA 71270 or call him at (318) 251-5858. The opinions of any single advisor do not necessarily reflect the opinions of Argent Advisors, Inc. No forecasts can be guaranteed. Argent Advisors, Inc. does not offer tax, insurance or legal advice. The information contained in this column should not be construed as a substitute for personalized investment, tax, insurance or legal advice.