Posted on | April 15, 2012
What You Don’t See Can Hurt You
You’d never tolerate a thief who was openly trying to steal your hard-earned money. But there are unseen thieves that rob us of our money just as surely as the stereotypical stick-up man hiding behind a bandanna.
Taxes, market volatility, and inflation are an unseen trio of villains that take our money from us quietly and methodically. Once you understand exactly how these influences can rob you blind, you can start to employ the strategies that will protect you from their predations.
There are three simple strategies that can keep your serious money safer, no matter what is going on in the economy.
The first is liquidity. This simply refers to having the ability to access your money when you want it or when you need it. If burdensome laws and regulations prevent you from getting to your nest egg when it’s needed, it’s of little use to you. Many people and even organizations find themselves in trouble because they lack liquidity at crucial times.
Safety is the next requirement. This refers not only to how much you trust the institutions where you trust your money, but also the safety of principal, meaning whatever you set aside or invest for the future. Your money needs to not only be protected from loss, but also any time you make money on that investment, the gain should become newly protected principal.
The third component is rate of return. You must be able to have predictable rates of return, no matter what the economy is doing. It’s no secret that mutual funds and the stock market can be a regular rollercoaster ride. But there are investment vehicles that can provide a safe and predictable rate of return that’s also tax-free. For instance, indexing allows you to participate in any market upside, but also protect your principal from loss during those times when the economy goes down. This translates into capturing the benefit of those up years and eliminating the loss of the down years.
These three components of liquidity, safety and rate of return are the basis for what’s known as the LASER test for soundness in an investment.
Indexing As a Tool for Growth and Income
There are two distinct phases in a person’s financial life. There is a growth phase during which a person will be actively accumulating income through growth vehicles. Next is the income phase in which they are taking distributions or withdrawals and living off the income provided by the nest egg they’ve saved. A key goal of the income phase to ensuring that you don’t end up outliving the money you’ve put aside.
Whether you are focused on growth or income, there is a vehicle that can be used in either phase to produce predictable rates of return. This vehicle is known as indexing and it lets you participate in the benefits of market growth while at the same time protecting your money from being at risk in the market itself.
How well does indexing work?
Well, consider this: If you eliminated just the loss years from the last 60 years of the stock market and captured just 25 percent of the up years, you would still have outperformed the average mutual fund or stock market investor. Getting the predictable rate of return is only part of the goal with indexing. The real secret to seeing your nest egg grow is to allow it to accumulate tax-free where the power of compound interest can do its magic.
To illustrate how this works in both the growth and income phases, imagine that you’ve accumulated a $1 million nest egg. Using indexing, that nest egg should generate around $80,000 per year in tax-free income. And it should do so continually without depleting the original million dollars, as long as you live.
Those who’ve had their nest egg at risk in the market have seen the value rise and drop precipitously. And those who’ve gone the tax-deferred route quickly find that when they start paying the taxes they owe, they have much less of a nest egg than they originally thought.