May 2011 - Posts - Kahler Financial
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Kahler Financial

May 2011 - Posts

  • Who Is Rich?

    Before fighting a war, it’s a good thing to know your enemy.

    Our federal government spends almost $2 for every $1 it receives. Our national debt is now over $14 trillion, representing almost 100% of our Gross Domestic Product (national income from all sources). How do we fix this before the country tumbles into economic collapse? To most economists, the obvious solution is some combination of reducing spending (including benefits like Social Security, Medicare, and Medicaid), increasing taxes, and increasing inflation.

    To most Americans, cable news shows, and even the President, however, the obvious solution seems to be "tax the rich." A recent survey found that almost 60% of Americans oppose reducing entitlement programs but would rather raise taxes on "the rich" who need to pay their "fair share."

    The class war against "the rich" in the U.S. has reached a level I’ve never witnessed in my life. There was a time in U.S. history that accumulating wealth was seen as virtuous, a byproduct of hard work and the pillars of freedom upon which this country was founded. Not any more.

    Let’s set aside for a moment the niggling fact that, even though marginal income tax rates fell for the top 1% of income earners over the past 30 years, their "fair share" of the total individual income tax revenue collected increased from 29% to 40%.

    Instead, let's concentrate on defining "the rich" so we know who the enemy is. A recent Facebook post by someone demanding we raise taxes on the rich defined "rich" as, "If your money works for you and you don’t work for it."

    Let's look at some potential enemies in the war on the rich.

    Holly, age 60, inherited $100 million from her parents. She draws $4 million a year in earnings, of which 50% goes to pay local, state, and federal taxes. She doesn't hold a job, but spends most of her time championing a number of charities and globe-trotting. Certainly, her money works for her and she doesn’t work for it, so she qualifies as "the enemy." Those wanting to tax the rich more would agree Holly should pay more, maybe 60%, 70%, or even 80% of her earnings in taxes.

    Diane, age 50, owns a small business valued at $2 million. It earns $1 million a year and pays about half that in taxes. Diane lives on $90,000 a year and reinvests the balance in her business. Last year she was able to hire two new employees. Is Diane rich? Should we raise her taxes? If so, she will almost certainly cut back on business expenses and perhaps lay off employees.

    Justin, age 35, is a corporate executive who earns $1 million a year. He pays about 50% of that in taxes. He lives lavishly, typically spending more than he makes. With no assets and $100,000 in credit card debt, Justin is basically insolvent. Is he rich? Should we raise his income taxes?

    Mary is 75, widowed, and retired from the successful business she and her husband owned. Her net worth of $5 million from the sale of the business is invested in CDs. They earn 1%, giving her a retirement income of $50,000. Certainly, Mary's money works for her and she doesn’t work for it, so she qualifies as "the enemy." Should we raise income taxes on Mary? If we do, we will be raising taxes on most of the people who want to tax the rich.

    What do you think? Who are the enemies: Holly, Diane, Justin, or Mary? If there's going to be a war against "the rich," it's important to identify the enemy.

    Rick Kahler, Certified Financial Planner®, MS, ChFC, CCIM, founded Kahler Financial Group, and became South Dakota’s first fee-only financial planner in 1983. In 2009, Wealth Manager named Kahler Financial Group as the largest financial planning firm in a seven-state area. A pioneer in the evolution of integrating financial psychology with traditional financial planning profession, Rick is co-founder and co-facilitator of the five-day intensive Healing Money Issues Workshop offered by Onsite Workshops of Nashville, Tennessee. He is one of only a handful of planners nationwide who partner with professional coaches and financial therapists to deliver financial coaching and therapy to his clients. Visit KahlerFinancial.com today!

  • Predicting Investment Returns

    Optimism and positive thinking are important assets in a great many areas of life. When it comes to investing, though, a healthy dose of pessimism may be a lot more useful.

    This is especially true when it comes to estimating long-term returns and projecting the level of income you can expect in retirement. Any investment advisor who tells you to expect average returns of 10%, 12%, or more is either an unreasonable optimist or an opportunist. The actual numbers for past investment returns over time simply don’t support such high percentages.

    One of the consistent optimists when it comes to predicting investment returns is radio talk show host Dave Ramsey. His website contains some great advice when it comes to investing, such as maxing out 401(k) accounts first if you have them, not buying individual stocks, and investing consistently over time.

    Where Ramsey’s unreasonable optimism comes into play is his assumption that growth stock mutual funds will give you average returns of 12%. His website says, "Over the last 30 years, the S&P 500, a standard measurement of stock market performance, has averaged a 12% growth rate."

    Based on the assumption of 12% returns, then, Ramsey says retirees can withdraw 8% a year from their portfolios, leave in 4% to cover inflation, and thereby maintain the buying power of their principal. Obtaining a 12% return depends on two assumptions: that having 100% of your portfolio only in stocks is a good idea, and that such a portfolio will return 12%. Both of these assumptions are mistaken.

    Thomas De Jong, a financial planner from Sioux Center, Iowa, who is affiliated with Money Concepts International, recently sent me an article pointing out that Ramsey’s 12% figure is "not even close to accurate." He does the math to show us why. The following paragraphs are from his article:

    "From January 1, 1926 to December 31, 2009, the stock market returned an ANNUAL AVERAGE rate of 11.92%. That’s pretty close, right? No. That’s NOT the compounded, or annualized rate of return, which you need to use if you’re going to forecast how your account grows over time (true rate of return).

    Here’s an example: You have $10,000 in an account. In year one, you make 100% return, doubling your money to $20,000. In year two, you lose 50%, cutting your $20,000 in half back down to $10,000.

    Annual average returns add your returns together and divide by the number of years. So 100% - 50% = 50% divided by 2 years = 25% annual average returns. However, at the end of 2 years, you only have your original $10,000, so you actually made ZERO.

    True rates of return are compounded, or annualized. The ANNUALIZED rate of return of the market from January 1, 1926 to December 31, 2009, was 9.84%. Adjusting for inflation, the stock market has returned 6.63% on an annualized/compounded basis from 1/1/1926 to 12/31/2009, and that's before investment expenses and taxes!"

    De Jong and I might be considered pessimists, but we'd say we're realists. The numbers he cites are the reason I estimate returns for my most aggressive portfolio at 8.0% and my most conservative at 5.0%. This is also why I agree with the conventional wisdom of limiting retirement withdrawals from a moderate portfolio, invested in an equal balance of stocks and bonds, to 4%. That percentage is based on a strong body of research by investment professionals.

    Maybe my projections are overly pessimistic. So much the better. If my clients are going to be surprised by returns different from what I’ve estimated, I would much prefer those surprises to be happy ones.

    Rick Kahler, Certified Financial Planner®, MS, ChFC, CCIM, founded Kahler Financial Group, and became South Dakota’s first fee-only financial planner in 1983. In 2009, Wealth Manager named Kahler Financial Group as the largest financial planning firm in a seven-state area. A pioneer in the evolution of integrating financial psychology with traditional financial planning profession, Rick is co-founder and co-facilitator of the five-day intensive Healing Money Issues Workshop offered by Onsite Workshops of Nashville, Tennessee. He is one of only a handful of planners nationwide who partner with professional coaches and financial therapists to deliver financial coaching and therapy to his clients. Visit KahlerFinancial.com today!

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