Wealth Traps Your Financial Planner Isn’t Telling You About
Hello and welcome to today’s episode. Today we’re going to discuss wealth traps that you need to avoid. The first big trap is saving money. That’s a trap. After World War II, America boomed. Many of the returning soldiers, returned in better health with better education than when they left. In the men’s absence, women had learned new valuable workplace skills, and our manufacturing sector had become robust. We were booming. Medical technology advanced rapidly, improving the health and increasing longevity of people, jobs were plentiful, the suburbs were blooming. Optimism was in the air, you could smell it. The US was looked on favorably by the rest of the world, do you remember that? We have helped save the day. The American people were on top of the world.
Now Europe is picking up the rabble, rebuilding their infrastructure and economies. They couldn’t compete with the US in technology or finance. Germany’s science was had been lured to the US to work here, and Japan limped along with a crippled economy. China was still largely a backward in nation. Russia had lost over 7 million of its citizens. The American economy boomed for decades without competition, with its powerful work ethic. It wasn’t too hard or difficult during these boom times to get a decent return on in exchange of time for your dollars. Prosperity abounded, and the trappings of prosperity were apparent. We had telephones, washing machines, televisions, beautiful giant cars, airplanes, rocket ships — the sky was the limit. What we had learned from previous generations about saving money seemed more sensible than ever. I mean this tried and true financial wisdom was simple and effective.
Exchange your time for money in a job with a great company, and religiously save a portion of those earnings. Buying a house and paying at office as fast as you can made a lot more sense in this era. You worked a job for 30 to 40 years, you saved up a great big pile of money, you paid in the social security and perhaps were blessed with a pension one year when our working days were done. This plan worked for a long time, and most Americans did well with this advice until 1971.
In 1971, everything changed. There were a series of economic measures in that year dubbed the Nixon shock. They were enacted by President Nixon and the rules of money had changed forever. There were some good things and bad things about the Nixon shock measures, but one thing was certain, saving money became a lot less profitable. However, this truth was never really communicated to the American people. People just kept riding on with that old outdated traditional — really, just antiquated advice, as a means to provide for their future.
The main policy that struck a blow to our savings was leaving the gold standard. Prior to 1971, a US dollar was directly convertible to gold. Since gold is a rare tangible product, it holds its value. When currency is backed by gold, called commodity currency, inflation is held in check. Contrary to that, fiat currency is simply banknotes printed by the government. It’s not fixed in value by any objective standard because there’s nothing backing it other than the belief of the people that are using it. Fiat currency, therefore, is much more prone to inflation. Its value is significantly eroded over time as the government prints more and more to bail itself out of one trouble or another.
Since 1913, when the federal reserve system was put in place, the accumulative rate of inflation of the US dollar is 2,303.5%. Something that would have cost you $20 in 1913, costs you $480.70 today, and this isn’t just because stuff cost more, it’s because your money is worth less. Because of our current fiat system, our savings are eroded by inflation. Now another fact that made saving more problematic as time went on, was the growing problem of longevity risk. Just after World War II, life expectancy was 62 years old. By 2010, the life expectancy was close to 80. You see those extra years represent a lot more cash that the average retiree must save and accumulate. Medical expenses have also sky-rocketed, adding to the financial cost of living longer. Honest estimates for what the average retiree needs to achieve a manageable retirement sit right around a million bucks. That’s more than is practical, or even possible, for most people.
I’m not saying that saving money as a principle is a terrible thing to do, but saving alone will not get you where you want to go. If you are going to really retire, you’re going to need to save a lot. The problem with that is you can end up scrimping for tomorrow while the most healthy and active years of your life just fly by. Focusing so intensely on providing for your tomorrow can rob you of your enjoyment today. Is that the life that you want? Is it enough just to get by day after day, working for your someday while being ground down in the present? What if, as is the case with most Americans today, you’re not able to save enough? You just not going to be able to retire, you’re never going to be able to stop working. You could rely on the government, or you could rely on your church or your family to support you. You have to ask yourself, “Is that the way I want to spend the end years of my life?” You could further double down on saving right now and try to catch up. In that case, what would you need to sacrifice right now? What would you have to give up? What would your family have to give up? What kind of life do you need to live right now in order to safely provide for your future, if that were your plan?
Perhaps you’ve heard that you can save more effectively with the tax deferred plan. I wish that were true, but we’ll discuss in great detail a little later. The point here is, wealth trap number one is the concept of saving money. If inflation doesn’t get you, the longer years of your life will, and then both probably are going to crush you if saving money is your strategy. That’s wealth trap #1.
Wealth trap #2: budgeting. You’ve got to have a budget, right? A lot of financial gurus stress reducing your expenses as one of the most important things you can do to become financially free. They teach you to cut out your daily Starbucks for example, and then save and invest that $4 a day. It is important that you learn to be disciplined with your expenses; however, the bigger picture is that you’re better served by focusing on how you can earn a dollar rather than on how you can save a nickel. Cutting expenses can certainly have a place in your overall financial plan, but it’s a misguided approach to put all your focus and energy on that. Why not put more focus on increasing your production? Why doesn’t anybody ever teach us to do that? We’re taught to live within our means, right?
That certainly is wise advice. The problem with it is that few people think in terms of increasing their means to live that advice, instead we always think in terms of decreasing our expenses. By definition, this is a very limited approach. There are only so many expenses you can cut, but increasing your production is limitless. I’m not saying to use this as a way to justify your expenses — no, be wise about your consumption. Be responsible, be thoughtful, particularly as you are building your way to financial freedom. Don’t buy a bunch of trips and toys and go out on nights on the town, live it up and think, “I’m just going to get up tomorrow and earn more money to pay for it.” Don’t do that, that’s not what I’m saying. I want you to focus on increasing your production and your cash flow, and then use your increased cash flow to purchase more assets. Then your assets can pay for your fund. Then your assets establish the new means of which is suppose to live within.
We’re going to finish off with this one, and this one is probably going to upset you a little bit. That one is maxing out your 401k. Yep, it’s a trap. In 1978, a tiny part of a law called the Revenue Act made it possible to save money and defer the tax liability. Sounds good, but it wasn’t planned out, it wasn’t tested or really even thought through. Soon, this provision known by its place in that bill as line 401k became the nation’s default retirement savings plan. People adapted it with great hopes that they would soon be amassing these giant piles of money on a tax-deferred basis. Sounds great. It looks good on paper even.
In reality, 401k plans have been a complete failure. As I’ve mentioned today, the financial world was very different in the 30 years after World War II. The three pillars of retirement consisted of pensions, savings, and social security. All in all, the working population had great confidence in these three pillars, and in their financial security in their elder years. Pensions were paid out by their employers. It was a fixed monthly benefit achieved after years of service to a company. Some people don’t even know what a pension is today.
Then banks offered a reasonable savings rate, and Uncle Sam promised to help out as well to fill in the gaps. Of course you’d be able to retire. There wasn’t a question. But within one generation — boom! All of that is evaporated. Uncle Sam has been completely incompetent as a money manager, social security is going broke, it’s only a matter of time. As it is, the monthly benefit for most people from social security is less than $2,000 a month. It might work as a supplement but it’s not going to provide any sort of manageable retirement on its own.
The interest rates offered by banks and savings accounts have plummeted. They go up and down, and perhaps they all have come back up to an acceptable level but it won’t likely ever be enough as demonstrated in the savings wealth trap. Pensions have been largely abandoned in favor of 401k plans. Very few companies offer pensions because they are expensive compared to offering match contributions to 401ks.
In 1980, almost 85% of private industry employees benefited from a company pension plan. By 2011, less than 20% of workers benefited from them. In that same time period, 401k participants grew from basically zero to more than 50 million people. Corporations love 401k plans, why? Because all the risk is shifted to the employee, and the corporate employers pay out much less money, and it’s cheaper for them. They even get a nice tax break for contributing to your plan, and this is all packaged up as a favor to you.
Not many years from now, we’re going to be looking back at the 401k, shaking our heads in disgust at society. We’re going to wonder why we ever bought into it, and how we could’ve ignore the evidence of its failure for so long. How did this obscure section of a law becomes so prevalent and popular? Yet, this is what the average person is being sold every day. Max out your 401k, keep stuffing money into that sack and everything’s going to be all right. The idea is only 30 years old. It’s barely enough to get a sense if it’s going to work or not or how it’s working. Now that we can see the initial results, it’s crystal clear, 401ks simply aren’t working and there are three reasons why. They found three categories.
The first is that, the 401k idea is simply the contemporary version of the idea that if you just save enough money, you’re going to be okay. Most people don’t even know or care what they are even invested in. They are simply comforted by the fact they are saving money. This is not wise investing, it’s wishful thinking. Even more importantly, it’s not happening. People aren’t generally able to save and grow merely enough wealth in their 401ks to retire. Here are the stats: the median 401k balance at retirement age for the average American is right around $100,000. That’s about a tenth of what is needed for the average person to retire “comfortably”.
Let’s say that you’re not average. You’re among the higher income earners of society, and you earn over $100,000 a year. In that case, your 401k savings average right around the retirement age is $350,000. That might seem like a big chunk of money to you, but it isn’t. You aren’t even halfway to the amount you’re going to need to ensure your retirement with anything resembling your current lifestyle. You’re not even halfway there.
The second reason why 401ks are a disaster in the making is market risk. The money could simply evaporate. If you are invested in the 401k, your future livelihood depends on consistent market gains and wise investing. Most people did not pick their plans with input from wise investment gurus, they simply went with the one that was provided. Can you rely on that outcome? Market investing carries significant risk, and that risk is not even in your control. You have the possibility to gain more than you can in the standard savings account, but that possibility comes with risk. One of the first rules of investing is that you should never invest more than you can afford to lose. My stories abound about people who put their financial faith in their 401k, only to find it depleted by market risk. Just because it’s a retirement plan, doesn’t mean that the market is going to cooperate. Many seem to take for granted that the market is just going to simply go up and up and up and that’s just not how it works. Losses are not easily regained. Your dreams for your future can be devastated overnight.
But wait…there’s more?!
This post has been adapted from the Epic Wealth podcast. Click here to listen to and see the full show notes page for this episode.
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Hi! My name is Matt and I’m the guy behind EpicRealEstate.com. I am a fifth-generation California native and Desert Storm Veteran (USMC) and have worked as a full-time real estate professional since 2003. After building a small real estate empire with hardly using one dime of my own money or one point of my own credit (mostly because I was lacking in both), I have discovered that I have a knack for simplifying the complicated, implementing systems and producing desirable results for myself and others.