What’s your retirement plan?

One of the sad truths about people, especially with regard to their money, is they almost always have to experience some kind of major setback prior to making a plan. In other words, people tend to react as opposed to prepare. And often, even when they do prepare, it’s not enough.

For example, what’s your plan for Social Security? Did you know a bad decision on Social Security can reduce your lifetime income by as much as half? It’s the most important retirement planning decision most people will make, and as many as 97 percent of retirees make the wrong decision, according to Forbes (you can find the link on our website, FreetoRetireRadio.com). Many people believe this is a zero-sum game, meaning to pay Paul, you must rob Peter.

And legacy planning models require that. They assume you start out with a finite amount of money and you will never have more than that. At the same time, they claim a well-managed portfolio should bring in 6 percent to 8 percent per year. The truth is, you can’t believe a thing they say.

Right now, the market is still near its all-time high, and doesn’t seem to be stopping for anything. Yet, if you talk to a legacy income planning specialist, you will find the amount you should be spending each year has gone down by 25 percent over the past decade. It’s true. Until about 2007, the rule of thumb was 4 percent. To see what I mean, search “4 percent rule” on the internet.

If you do, you will see a bunch of stuff about how the rule came into being, what it means, and how it’s been used. You will also see that over time, it has shrunk. It’s now the “2.8 percent Rule,” according to Morningstar.

How can this be? We’ve been through one of the longest-lasting and highest-flying bull markets in history. How can the amount we pay ourselves be shrinking? It should be growing! Especially with the market up so high.

It’s because the market rates of return you are quoted are averages, and average rates of return are meaningless when it comes to spending, and frankly, they don’t mean that much when you are accumulating, either. But it’s spending where they are really meaningless.

Here’s an example. Assume the market goes up 60 percent year one, and then goes down 40 percent year two. What’s the average rate of return? It’s (60 percent-40 percent)/2 = 10 percent. So assuming you begin with $200,000 in your account, how much do you have after year 2? $200,000 x 1.1 x 1.1 = $242,000?

Nope, not even close. It’s actually $192,000! How can this be?

Now either way, the average rate of return is 10 percent a year, but what happens to the actual money could not be much different. The actual rate of return, which is what is most important, is just over -2 percent.

It has to do with the way gains and losses operate in the market. When you gain, you gain a percentage of the principal and it’s added to, or layered onto the principal (call it whipped cream on a pie). However, when you lose money, it attacks the whole pie and the whipped cream. That means, more comes off than went on. The actual math looks like this: $200,000 x 1.6 = $320,000 x .6 = $192,000.

Now, imagine if you had calculated you could take 5 percent income annual from your account’s beginning value while all of this is going on. I mean, you’re getting 10 percent growth, right? That math looks like this.

$200,000 -$10,000 = $190,000 x 1.6 = $304,000 -$10,000 = $294,000 x .6 = $176,000. So you earned 10 percent average return over two years, took 5 percent each year, and end up down 11.8 percent? What would happen in a situation where you lose almost half your money in a year? It could devastate you.

So how does delaying your Social Security help? With the market, the longer you live, the more of your money you must preserve, in case you suddenly lose a bunch. Social Security on the other hand, is not a zero-sum game. It’s an evergreen stream of income. That means, the longer you live, the more money you have. By maximizing that over your lifetime, you provide a much more robust guaranteed income stream that can last for the rest of your life, no matter how long you live. That can provide much more income over the long haul, than taking an early benefit that is as much as 80 percent smaller, putting much more strain on your investments over the long haul.

This is only exacerbated in a market downturn. If you had retired in 2007, by the middle of 2008 you had just about half the amount in your retirement accounts if you just rode it out. And the fact is, you probably did ride it out if you were following a money manager’s advice. Why is that? Because Wall Street generally does not get paid for money that’s sitting on the sidelines. So, it’s posture is stay 100 percent invested 100 percent of the time, even when the market is crashing.

But what does Wall Street do when the market is crashing? Do you think those “masters of the universe” just stay in, watching their holdings disappear before their eyes? What? You thought all those trillions of dollars just disappeared?

Professional traders know you can make just as much money when a market is going down, as you can when it’s on the rise. The only difference is it takes much longer to ride the market up than it does on the way down. We often say the market takes the elevator down, but must hike the stairs back up. So, when the markets are crashing, the big wirehouses and investment banks are piling on and making fortunes short-selling the market, which essentially means, selling borrowed shares. When the market is high, for example, they might borrow and sell a bunch of shares at 100. When the market crashes, they will pick up shares, perhaps at 50, which they use to pay back what they borrowed, making a killing in very little time. The only problem? They need a bunch of suckers to hold their shares until they are low enough to buy. That’s where you and I come in.