07
Apr
11

7 Ways to Lose A Million Dollars!

Yup, you read right, it says seven ways to lose a million dollars. A fantastic post I recently read from blogger David Vogelsang, known on twitter as @dvogel7921, inspired this post. The clever piece in question was entitled An Easy Way to Lose Three Million Dollars, where David compared some not-so-obvious ways we can lose large amounts of money over time.

I thought this piece was so brilliant in its comparisons that we Canadians need a dose of what David’s blog “Spreading Financial Confidence One Post At A Time” was dishing up. And since many Canadians can easily retire on a million dollars, I thought it would be fitting that this post show you how to lose one million dollars. I normally direct my message to the advisor, but I thought this post would make such interesting comparisons to share with your clients. Which way are your clients losing their million dollars? And how can we help them prevent some of these missteps?

1. Stretch your car budget by $15,000.

My golden rule when it comes to buying a car is never buy anything you can’t afford to pay off in 36 months or less. For example if you bought a $35,000 car when really all you could afford to pay off in three years was a $20,000 car, that would mean you regularly have to stretch your car loans over 72 months to keep that  monthly payment where you can afford it.

The total cost of those vehicular upgrades over your working life amount to 1,226,760. If you had bought the $20,000 car and invested the difference and over the very long term earning an average of 8% growth you could have funded the bulk of your retirement!

 ($20,000 car over 3yrs @ 4% = monthly payment of $590.19. If you purchase a $35,000 car you need to pay it over 72 months to get the payment down to $547.06. If you bought a new car every 7 years [from age 25 to 65] the total additional financial opportunity cost would be $1,226,760.)

2. Decide you don’t “feel lucky” and pass on the purchase of what turns out to be a winning lotto ticket bought jointly through your office pool and find out after you see the rest of your co-workers on TV with a giant cheque that you missed out.

3. Fill up your RRSP!

Yeah you read this one right too! If you filled up your RRSP (I’ll assume $20,000/yr for simplicity sake) from age 35 to 65 and it grew at 8% you would have about $2,265,664. Since no one would know what their tax rate would be in the future, I’ll assume 40%. If you wanted a net withdrawal of only 5% per year of $110,000, you’d have to take a withdrawal of $183,333, meaning there is $73,300 in taxes payable on those withdrawals.

Now, yes income splitting can help, but not if the total household income is high. Income splitting only works to your advantage if incomes are uneven and if you are part of a couple. I haven’t even factored in what the potential loss of government benefits would be.

Now for those who let their tax tail wag the dog and are saying to themselves, “Hey, what about the tax refund from depositing that $20,000 per year for 30 years?”  If we subtract the tax refund you’ve still lost up to $1,533,325. And for those of you who would argue fair math means taking the refund and reinvesting it, well when I come across actual people who do that I will be sure to make my math reflect it. The fact of the matter is we all know few clients reinvest their full refund each and every year. When I add the human to the equation this is the result.

(Just using some very basic, straight-line math, the tax cost of taking a $110,000 net income from that $2,265,664, after 25 years (from 65 to 90) you would lose $1,833,325 in taxes. Tax savings: $20,000 deposit = max refund $10,000 per year for 30 years = $300,000)

4. Take out a business loan for $1,000,000, don’t follow your business plan, lose the business and go bankrupt.

5. Don’t contribute to your group RRSP.

 The only RRSP I happen to like!  This is because while there will be tax consequences down the road, the employer match is still free money. If you make an average salary over your working life from age 25 to 65 of $88,000 and refuse to participate in a group RRSP where your employer matches up to 3% of your salary, you could have looked a $1,016,068 gift horse right in the mouth!

 (88,000 @ 3% = $220/mo invested over 40 years at an average long term rate of return of 8% =$1,016,068.)

 6. Be mean to a rich relative and lose out on a $1,000,000 inheritance.

 7. Buy a house without 20% down!

When you can’t save a sizable down payment you often can’t save once you get into that house either. Say you bought a $400,000 house a few years ago with essentially 0% down (which is really a $28,000 line of credit now from the 5% $20,000 down payment plus closing costs and interest) and then took out a 35-year mortgage. To be clear 35 year amortizations of course are going the way to the dodo bird and you can’t do zero down any more but there are a lot of people who bought their houses that way.  Not that the math on only 5% down and a 3o year amortization is much better.

 Meanwhile, because things are tight, you rack up just two credit cards to $15,000 each plus that $28,000 line of credit and pay the minimum payments. If a down payment had been saved, the other debt would be less likely to exist. Having saved just half of the combined minimum payments on the credit card and line of credit per month over that same 35 years, you would have about $510,806. Total possible loss including interest and lost investment opportunity would be $1,118,842.

 (interest on a mortgage of $380,000 {$400,000 – $20,000 down [on the line of credit[} over 35 years at an average rate of 5.5% is $470,606, plus interest costs on those two credit cards @ 12% at $307/mo would cost $95,078 and the line of credit $167/mo totaling $42,352 over that same 35 years, total interest cost: $608,036.  Half of the minimum credit card and line of credit payment would be $237/mo @ 8% average return over 35 years = $510,806.  If you are looking to buy now a days you can’t do 0% down or finance over more than 30 years the math on 5% down and 30 years {still having the same amount of outside dedt} at the same interest rates still costs $391,423 + other debt interest $137,430 = $528,853 + lost investment opportunity $510,806 = $1,039,659 still over a million dollars even if you use the new rules! )

While we may be doing our darndest to help our clients understand these things, sometimes an interesting way of putting it like this post can be the key to having your clients truly see where their retirement dollars may be hiding!

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Stephanie Holmes-Winton

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