Busting Common Myths - Encore

How much does an average rate of return matter? Or does it even matter at all? And what about your 401k? Is the way you’re approaching it the right one? Listen to this episode to hear a few common myths being busted – and get all the positives that will come your way as a result.

• The other day, Brian came across a quote that read,‘If things you thought were true were actually false, when would you want to know?’ As someone who is continuously seeking information to either support his way of thinking or to provide more insight into what he’s thinking, he tends to be pretty grounded, thanks to that process.
• One of the biggest half truths out there has to do with an investment’s average rate of return. Brian often hears mutual fund companies, investment advisers, and colleagues of his discuss investment averages and he uses this information to make decisions about which investment to choose. If you look at the math, you’ll notice that an investment’s average rate of return doesn’t mean much.
• Let’s say you hear that an investment made a 25% average rate of return, then you would think that if you invested $100 over four years, you would have $244. Perhaps you would, but there are also cases where, with a 25% average, you would end up breaking even and end up with $100. Investments don’t typically have the same positive returns year after year – they can fluctuate up and down, and that’s what creates an average over time.
• If you made a 100% rate of return, one year, your $100 would become $200. If the following year you would lose 50% you would go back to the original $100. Think of it for a moment: if you took a 100% gain, 50% loss, 100% gain, 50% loss fluctuation, your average rate of return would be 25%.
• The next myth has to do with your mortgage. Quite often, Brian hears conversations related to the fact that, according to popular belief, doing a 15-year mortgage over a 30-year mortgage is the way to go. This typically stems from the idea that if you pay on a loan for 15 years compared to 30 years, then you’re going to pay less interest.
• That is indeed true, but there’s more to the equation than simply looking at the interest paid. Too many people get hung up on just interest rates and very micro topics. However, whenever you look at a financial topic, it’s important to look at it in a macro view, and make sure that you consider all the variables that come into it.
• Then, there’s something many people contribute to without actually understanding how it really works: their 401k. Why contribute to someone you don’t know much about? Many people do so simply because contributing to a 401k is convenient and offers a tax deduction.
• And there’s even a myth within the myth: the misconception that the same tax code exists for people working as they do for people retired. This is actually incorrect – while it’s true that some of the income one receives in return is taxed differently, the tax bracket used is actually the same. The IRS doesn’t offer a tax bracket just for retirees.
• As you’re thinking about your finances and your retirement, there’s a trap some fall into, and that is not understanding that some tax deductions may be available now but they won’t be in the future.
• Brian has three examples of tax deductions you may be getting now but might not be getting later.
• The first one is your 401k: as you get ready to retire, you probably won’t be contributing to it anymore. Then, there are your children. When they don’t live with you anymore, you won’t be entitled to receive any child tax credits. And, lastly, your home mortgage interest – if you have your home paid off before you retire, your interest deduction will be decreasing.
• And in case you’re thinking about accessing your 401k money, you’d better think again. In fact, there’s a 10% penalty fee in place for those who decide to touch that money before they are 59 and a half. That money can only be accessed without penalties when you reach that age or when you terminate the employment the 401k fund is tied to.
• On the flip side, when you are 70 and a half, they force you to take the 401k money out whether you need it or not…
• Here are a couple of questions worth reflecting on: ‘Does it make sense to risk deferring taxes and retirement just to get the tax deduction?’ and ‘Does it make sense to pay taxes now when we know what the tax codes are?’