GREEN Financial Blog: When is a 7% return better than a 10% return?

real estate investment returnHow many times have you heard a financial adviser state, “If you keep your money in the stock market for the long run, it will return over 9 or 10%?” Clients that I talk to never seem to get excited when I mention that the returns on an equity-indexed universal life insurance have historically returned over 8% per year. Worse yet, when I run illustrations for clients, I generally show them at 7% or 7.5% to be conservative.



Let me ask you this question: If you are lucky enough to have your money growing at 10% per year in a traditional IRA or 401(k) plan, what will your net return be after you pay your taxes? If you are in a 28% tax bracket, then that means you will be averaging a little better than 7% after-tax.


Let that sink in. You kept your money in the market at risk of 20 ̶ 40% losses in any given year due to market volatility. You hoped that, over the long run, your portfolio would average at least a 9%. And when you took your money out and payed your taxes, you were only left with just over a 7% net return.



You shouldn’t have to work that hard just to earn a 7% return when there are options available to you that have achieved over 8% historical returns with no market risk.


Now that I have explained how a 7% tax-free rate of return might be better than a 10% taxable rate of return. I want to show another way that a 7% tax-free rate to return may be better than the 10% rate return that the financial “experts” say you can achieve in the stock market.


Do all of the experts on Wall Street work for free? Does YOUR financial advisor work for free? So where are they making their money?


Let’s look at a typical 401(k) for example. There was probably a financial advisor that came into your company and convinced the owner that his big Wall Street firm should manage the owner’s retirement plans. You can rest assured that that financial advisor is making some percentage of every dollar that is managed.


That financial advisor works for a company that is also taking a small percentage of every dollar that is managed. And more than likely, the company is simply farming out the money to a group of closely held mutual funds where they may have a financial interest. These mutual funds also charge management fees that are assessed as a percentage of the dollars managed. And usually the bigger the name, the bigger the fees.


So let’s say that the S&P 500 index returned 10% in a given year. And just to be clear, many mutual funds use S&P 500 as a benchmark to judge their own performance. So if the S&P 500 returns 10% and your financial advisor is taking out a 0.75% fee and his company is taking out another 0.75% fee and the mutual fund management company charges 1.5%, you are only netting 7% return even though the market returned 10%.


Just to be fair, fees in the industry are all over the board. There are index funds that offer no professional management—they simply buy the funds that make up the index—and their fees are very low. But every professionally-managed mutual fund charges fees. The industry average is over 3%.


These fees are charged whether the market goes up or down. In years were the market goes down you are taking your loss while your advisor, his company, and the mutual fund managers are all still making money.


We all need to make money. But there are better ways to fund your retirement savings that assure that you don’t get kicked when you’re down and don’t hinder the rate of return to the extent that traditional Wall Street investment do.


By simply picking investment and savings vehicles with low expenses, you can outperform traditional Wall Street investments by as much as 2.5%, year after year based on industry averages. When you compound that out over a lifetime of saving, it makes a significant difference in your retirement nest egg.

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