What the Rich Know and the Poor Don’t

rich and poorBy David John Marotta

Financial planning is important, but it is never urgent. Most people fail to establish a financial plan because they fail to start planning. Some resolutions can be postponed, but for every six years that you delay saving and investing, you cut your retirement lifestyle in half. So, act on your resolution today.

To successfully build wealth, you must know the answer to two important financial questions. However, many Americans never bother to get the answer for themselves. Being able to answer these two questions is an important first step toward meeting your financial goals.

Depending on your station in life, this first question should be modified to fit your situation. For those who are still saving for retirement the question is “How much money do I need to save this month to cover my longer-term financial needs?” If you are already retired, the question is “How much money can I spend this month so that I don’t run out of money during my lifetime?”

Don’t try and sidestep this first question by thinking you will work forever. Assuming you won’t retire is not a good retirement plan. Neither is dying young.

If you are a woman, you are much more likely to outlive your family’s finances. If you fail to save enough during your working years, your investments may not keep pace with inflation or your spending may leave you out of money.

When you run out of money during retirement, you lose your lifestyle and your independence. Knowing how much you should be saving or spending minimizes the chance that you will outlive your money and provides you with peace of mind.

The second question you should be able to answer is, “What return on investment did your assets earn last year?” If you think a couple percentage points on your investment return each year won’t make much difference, think again. Adding a few more percentage points to your return, compounded over 40 years, will double your standard of living in retirement.

It is also unwise to assume that your portfolio earned roughly the same as the indexes reported in the news. Your asset allocation will determine the majority of your investments returns. Consider the following different returns for the exact same year.

In 2000, when large cap growth stocks lost 33.51%, small cap value stocks earned 18.58%. In 2001, when the NASDAQ lost 21.05%, the Russell 2000 Value earned 14.02%. In 2002, when the S&P500 lost 22.10%, the Johannesburg Stock Exchange Gold Index earned 130.33%. In 2003, when the Lehman Aggregate Bond earned 8.44%, Emerging Markets earned 42.34%. In 2004, when the Dow earned 5.31%, the Goldman Sachs Natural resources earned 24.57%. In 2005, when the S&P500 earned 4.91%, the EAFE Foreign Index earned 25.96%. This past year, in 2006, while large cap value was earning 25.78%, large cap growth only earned 5.68%. How did your portfolio do?

If a few percentage points can double your retirement lifestyle, having a proper asset allocation is what makes it possible to retire comfortably in the first place. Until you know the exact return of your investments, you won’t be able to evaluate the drag on your portfolio by being too conservative or the cost to your portfolio by being too aggressive. You also won’t be able to evaluate the hidden costs of investments with high expense ratios or transaction fees.

David John Marotta works at Marotta Asset Management, Inc. of Charlottesville which provides fee-only financial planning and asset management.

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4 Responses to What the Rich Know and the Poor Don’t

  1. Minimum Wage says:

    It doesn’t matter how much you “need to save this month…” if you don’t have it.

    Yes, I fully understand that I have NO assets and that I can expect to become unable to work before I die and that I will become destitute in this event.

    So I’m a poor person who already knows these things.

  2. dan says:

    While I don’t know the extent of your situation, if you don’t have enough money, then you need to figure out a way to make money. The fact that you can comment on this site means that you have the skills to make more money. Begin a blog of your own or write for one of the many sites that now pay people to write articles.

    If you know the situation, you need to take the steps to rectify it. Nobody is going to do it for you but yourself.

  3. Jenny says:

    There are many ways to earn extra money. One of the age old keys is saving first and learning to live on what you have. That seems an easy thing to say but may be really tough depending on your individual circumstance. One of the things to do is to really examine how you are spending your money. Challenge yourself to track your spending for a week…a month would even be better if you can discipline yourself to write it down! Then look at essentials and non-essentials. How many pops are you buying at work? If you are spending $1.50 per day x 5 days = $7.50 x 52 weeks = $390 per year. Over 45 years of working, that equals $17,550. That’s just a small example!! How many of us eat out and how often? How about flavored coffees at our local coffee shop? Imagine what that money could come to if we were to invest it instead!? I think you get the idea!

    If you have access to a retirement plan through work, you need to try and max out what you put in. If your employer matches your money; you’re throwing money down the drain if you don’t take advantage of it. Remember, the money that you put into work retirement plans is before taxes are taken out, so your money is really going farther and you are not taxed on that money until you start taking it out at retirement.

    IRAs may also be an option with my favorite being the ROTH IRA. Since you are contributing to it with after tax money, you also do not have to pay any taxes on the growth when you start drawing on it in retirement. What a fabulous bonus!

    Be sure to consult with your tax advisor or insurance and financial services advisor to help determine the best options for your individual situation. Be sure you are taking advantage of all of your tax exemptions and write-offs.

    It can be tough to make extra money when you are working at jobs barely above minimum wage and are being scheduled so many hours that you barely meet yourself coming and going. You may even feel trapped in a job and feel like you have no other options. If more education is needed; there are many programs that you can do in evenings or on-line to further your education. Depending on your circumstances there may be grants and programs available to help with your educational costs.

    Your local employment agencies may also be a good option for finding temporary work or work-to-hire positions. Many employers also may only advertise through these sources…especially through state run programs.

    A lot of us go through rough spots in our lives and find curve balls that punch a hole in our plans. That’s when we re-examine, adjust, and go to plan “B”, (or”C” or “D”.

    One last thing…where do I find sites that pay you to write??

  4. Zook says:

    Minimum Wage- Stop reading this stuff already. You continue to howl at the moon. Face it, you will work until you die and will never get ahead. Just face the facts already. Your way is working so far, not sure why you even read.

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