Will Your Nest Egg be enough?

There's really very little doubt left about it. In order to achieve financial independence and freedom, the average American is going to have to take some degree of risk. With life spans, and thus retirement years, getting longer and Social Security not even coming close to providing enough for most people to live on (it was never really meant to), it's necessary to realize that the time to provide for one's later years is right now.

But what do you do? Where do you begin? Well, you can start by looking at how long you have before you reach retirement and how much money you're going to need when you get there. If you can first determine your projected monthly retirement expenses along with income, then you'll easily be able to see any shortfall. A shortfall is the difference between the amounts that you'll realistically need to have and what you anticipate that you actually will have. You'll also need to determine how much you can begin investing with.

Let's say that you figure out, for example, that you're going to have a shortfall of about $300,000 and you have 20 years left before you reach retirement age. You have $50,000 from the sale of a piece of property available to invest. In this situation, most people would plunge into one of the "hot" investments advertised in a money magazine, or seek the help of a traditional financial planner or stockbroker. Unfortunately, if you take one of these approaches you could still have a problem, because most investment sales organizations operate within the framework of pretax returns and relative performance.

Most investors use the model of total return based on historical performance as their primary (if not their only) financial gauge. But total return is nothing more than a visual display of the past; it's not an indicator of the future. And historical performance only reveals a small amount of the information that you actually need to know.

For instance, a stockbroker may show you a dollar goal projection, illustrating the magic of compounding using the historical rate of return of 10 percent (and all the while selling that 10 percent figure as conservative). At 10 percent, your $50,000 would grow to $336,000 in 20 years and $872,000 in 30 years, which certainly sounds impressive. But something important has been overlooked, and it's the fact that total return drastically overstates the future purchasing power you'll have because it ignores such things as taxes, fees, and inflation.

And these oversights, needless to say, can make a world of difference. With typical taxes of 2½ percent along with brokerage fees of 2½ percent, your 10 percent return assumption is now reduced to 5 percent. Doing the math, your $50,000 after 20 years would not be worth $336,000, but only $132,000. Subtract 3 percent for inflation, and real dollar projections would drop to a meager $74,000. In other words, without taking all factors into consideration you could find yourself literally hundreds of thousands of dollars off your mark, without the time necessary to make it up.

Your objective, therefore, should be to focus on the dollar amount that you'll need and on the total expected after-tax return – 'after-tax' meaning after fees, after expenses, after any and everything that stands in the way of you reaching your goal. Endeavor to control everything that's in your power to control. Make sure you understand what combinations of investments will give you the highest probability of making up any shortfalls, while at the same time reducing your costs as much as possible. It's your responsibility to operate your investment program with full awareness of all tax and fee consequences.

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