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Zach – Hello everyone, welcome to the Retirement Today podcast. My name is Zach Holcomb and alongside me as always we have certified financial planner president and founder of Centennial Advisors, Mr. Michael Reese, Mike, how are you today?
Michael – Doing great, and we have a great topic today, right? We’re talking about when is 8% return not equal to an 8% return, right? Something like that.
Zach – Yeah, you hit the nail on the head but it seems pretty crystal clear. We have to have a podcast about it. It seems pretty straight forward, right?
Michael – I know, it’s like if I earn 8% a year, isn’t that 8%? So here we go. I’ve got a great example though to share this a little story to share about why 8% is not always 8%. And by the way I could have used 6% is not 6% and 10% is not. I mean, any number is not another number but we’ll learn why. So here we go. Let’s imagine, you watched the movie back to the future. Haven’t you Zach?
Zach – Oh yes, absolutely.
Michael – Good movie?
Zach – Great movie.
Michael – There you go, and what’s really cool. Is this thing came out like 1985 or something like before you were born so clearly you’ve had good parenting, right?
Zach – Yes.
Michael – In any event, let’s imagine that tomorrow afternoon around, let’s say it’s a weekend. No, it’s Saturday. It’s the weekend. And so Saturday around one o’clock I stopped by your apartment there, and I say, and it’s, I pull up in the DeLorean like the car from Back to the Future. And I say, Zach, come on, buddy let’s get in. You’re like, dude, you’ve got a Back to the Future car. I’m like, yeah. And the flux capacitor is working, right? So, and you’re like, great. Where are we going? And I say, well here’s what we’re gonna do, Zach get in the car, it’s gonna be a surprise. You got nothing else going on. So you’re like, okay, fine. I’ll do that. And in the car you go. And then we got to get this thing I punch in in the little date thing I punch in January 1st, 2000. We get on a straightaway and I start accelerating Zach how fast do I have to go for that flux capacitor to work?
Zach – 88 miles an hour.
Michael – That’s right. Why 88 miles an hour?
Zach – That’s when the flux capacitor kicks in.
Michael – That’s right, I don’t know why it’s that speed but that’s what it is, right? So we’re going 88 miles an hour. The flux capacitor kicks in, boom. And back we go to January 1, 2000. Now you’re like, all right, Mike, why are we here? I said, okay, Zach, here’s what we’re gonna do. We’re gonna have a little fun. And what I do is I pull out a bag and inside the bag is a million dollars. It’s not monopoly money. I’m talking real money, a million dollars. And I say, all right, Zach, here’s the deal. I’m gonna give you this money but you have to deposit it into one of two places. You have to invest this money. And so here are your options. You can invest the money in an account at Vanguard or you could invest the money in an account at, some company you never heard of, we’ll call it ABC Financial, right? You never heard of them, but here’s the deal. We’re from the future Zach. So we know some stuff, right? We know that whether you put the money at Vanguard or you put the money at ABC, they’re both gonna be around 20 years later in 2021. And they’re both going to average 8% a year return after fees. We’re going to ignore taxes for this discussion, all right? So here’s your option. You can put the money in Vanguard, place you’ve heard of great reputation and you’re gonna earn 8% a year net, or you could put the money over it this ABC company that you’ve never heard of and you’re also gonna earn 8% a year net which company are you going to invest your money with? You can’t do 50, 50. It’s gotta be all in one place. Which one are you probably gonna choose?
Zach – Yeah, most people would probably choose Vanguard.
Michael – Of course they would, why?
Zach – Name recognition, brand. I mean, we know this name. We trust them. It’s something we’re very familiar with.
Michael – Yeah, we’ve heard about them, right? And look, if I’m getting the same return either way does it even matter?
Zach – No, not at all.
Michael – I mean, it doesn’t matter at all, does it? It’s the same. It’s 8%, 8%, same thing. So I’d go okay, cool. Million dollars in a name, Zach Holcomb ad Vanguard, right? We have back in the DeLorean. We punch in today’s date. We get that accelerator up to 88 miles an hour and boom, we’re back, back to where we started, right? All good so far?
Zach – All good.
Michael – Cool, soon as I drop you off I pick up your next door neighbor. Do you even know your next door neighbor’s name?
Zach – I do not.
Michael – Not an apartment complex, right? Let’s say it’s Bob. I pick up Bob and I do the same thing with him, right? Now, here we are in 2021. Now let’s imagine that you get your statement. Now you don’t actually get physical statements these days. Let’s say you get an email an email in January, January of 2021. It says, Hey Zach, your statement ready. So you don’t click it right away. Cause I don’t think anybody does. But you wait a few days, and eventually like, okay I got to click this thing, and you look it up, and you’re like, wow, look at this. That million dollars I invested way back on in 2000 here it is 20 years later, it’s worth $3.7 million, right? So Zach, your million dollars has grown to $3.7 million at 8% average. Are you happy?
Zach – Sure, 3.7 million is awesome.
Michael – It’s awesome, right? It’s fantastic. And you’re thinking, man, this is terrific. You’re like living large, right? And then you realize you’ve got to take out the garbage. You’re like, Oh geez. I’ve got 3.7 million. I still have to take out the garbage. It’s like, maybe I should just hire someone to do this, right?
Zach – Yep.
Michael – Anyway, so you’re taking out the garbage and you’re bumping your next door neighbor, Bob who’s doing the exact same thing. Bob’s like, Zach dude, how’s it going? And you’re like, awesome. Cause you’re flying high. You’ve got 3.7 million. And Bob’s like, Zach, my man. Did you look at your statement? Did your statement come in? You’re like, yeah. Awesome, right? And Bob says, yeah, $4.7 million. I mean, how cool is that? And you’re thinking, wait a minute, 4.7. Mine only says 3.7. You don’t wanna look dumb or stupid. So you’re like, yeah, man, that was awesome, right?
Zach – Sure, yeah.
Michael – Well, you go back into your apartment there and you look at your statement again. You’re like, yeah, it’s says 3.7. And now you’re thinking what’s going on? Bob my next door neighbor how does he have 4.7 and I only have 3.7? That’s like a million dollars difference. So you call me up. You’re like, Mike, I got a question. I’m a little confused. Hey Zach, what’s going on? Well, remember how we went back and we deposited that, that million dollars. Yeah. Well I got my statement from Vanguard. It says that I’ve got 3.7, but then I just bumped up to my neighbor, Bob, taking out my trash. And like he said, he has 4.7. What’s going on. I said, Oh, well Zach. Yeah, that’s just how it worked out. You’re like, wait a minute. I thought we were supposed to both get 8% average return. You told me that it didn’t matter. That’s what I’m gonna get. How did he get more? Well, here’s what happens Zach. He invested with ABC, the company you hadn’t heard or see, what happened was he was on the phone with Vanguard before we went and they just, I don’t know what happened. He got like the worst person who works at Vanguard and they just didn’t, it just didn’t work out for him. And he hung up the phone. He’s like, man, I’m never invest with Vanguard again. So when we went back to the past, he said anybody but Vanguard. He went with ABC. You’re like, yeah but we still both got 8% didn’t we? Oh yeah, you both got 8%. Well then why does he have a million dollars more? That makes no sense. Ah, well Zach that’s because there’s more to investing than your rate of return. And I’m gonna say that again. There’s more to investing than your rate of return. And you sit back and like, well, I don’t get it. What does that mean, right? I say, well, Zach, you know how whenever people talk about investing, what is investing all about? It’s about risk and return. Isn’t it?
Zach – Yep.
Michael – We only talked about return. What didn’t we talk about?
Zach – We didn’t talk about risk.
Michael – Yeah, we didn’t talk about risk. And here’s a problem when you invest money that nobody talks about, bad years or negative years hurt you more than positive years help you. So let me give you an example, Zach, let’s imagine let’s imagine that you invest some money in the first year, a hundred thousand dollars. The first year you make a hundred percent return. You double your money in one year, you start with a hundred thousand. You doubled your money in one year a hundred percent rate of return. What do you have the next year?
Zach – 200,000.
Michael – And you are the world’s best investor. You doubled your money in like one year. And right now you’re just, you can’t like everywhere you go you can’t wait to tell somebody about it, right? Cause you’re so brilliant. Well, what they say, what goes up must come.
Zach – Down.
Michael – Down, and so maybe the next year, not such a good year, you lose 50% and you start doing the math, right? You’re thinking, okay, let’s see I made a hundred percent positive the first year, I lost 50% the second year. Plus a hundred, minus 50 that’s well, that’s a net 50%. That’s plus 50% over two years, right? And let’s see. So 50% divided by two years. Oh, Hey, good news. I made 25% a year. I’m still pretty brilliant, right? But then when we put the math to your money we say, okay, you’re at 200,000, you lost 50%. What’s 50% of 200,000?
Zach – Lost a hundred K.
Michael – Which means you’re back where you started at a hundred thousand. So congratulations, Zach you averaged a positive 25% rate of return but somehow you lost or you broke even, pretty crazy, right?
Zach – It’s crazy.
Michael – Well, that’s what’s going on here in my example. See in my example, with Vanguard, that Vanguard portfolio did average 8% since 2000 that was the stock market. That was the S&P 500 that you put your money in. And guess what you had in 2008, a year where you lost 37%. And in 2002, there was a year where you lost 22%. But over at ABC mutual or ABC Financial, rather where your next door neighbor, Bob put his money, in 2008 when you were losing 37, he only lost like 12. In 2002 when you lost 22, he kind of lost like 1%. Meaning that he didn’t have big losses, you did. Now on the flip side, you had some really good return years. You had years where you’re making 28, 26, 28, 30% returns. Bob, his best year was up like 20%. He wasn’t making no 30% return years. But at the end of the day, he ended up with more money. See, it all has to do with this concept called variability or risk. So at Vanguard, that Vanguard portfolio that you put your money in, that most people put their money in, the worst year was minus 37. The best year was plus 32. That’s a 69% call it 70% range of returns. So when you start on January 1st you don’t know where you’re gonna end up. You might be up 32%. You might be down 37 or anywhere in between. That’s a really big range, 70%. But on your next door neighbor Bob’s portfolio over at ABC their worst year was minus 12. Best year was plus I think 21, that range instead of 70% it was only 33% or less than half. And here’s how math works with money. Whenever you look at two portfolios that give you the same average rate of return. The one that does it in a tighter, that has a tighter spread, right? That has less risk gives you more money at the end of the day. Pretty amazing isn’t it?
Zach – Yeah, those losses hurt you way more than the big game years.
Michael – That’s right. Yeah, lose 50%, you need to make a hundred percent just to get back to even, right? That’s what we learned there. Now, by the way, if you think this makes sense or if it makes a big impact, when you’re saving for retirement. It makes an even larger impact when you’re taking money out. So as this will be the last thing we talk about today. Imagine that the story changes a little bit. Let’s go back to 2000 and let’s imagine that you retired January 1st and you’ve got a million dollars. January 1st, 2000 you retire with a million dollars and you take out 4% or 40,000 for income, and then each year thereafter you increase your distributions by 3% a year, right? Now, when my father retired, Zach he came to me with his 401k, said, Mike I want you to do three things for me. Number one, protect my principle. Number two, give me some income. And number three, if you can grow it a little bit. Now, let me ask you something Zach, you talk to people every day who are getting ready to retire. Does that sound familiar at all?
Zach – It’s right up their alley. That’s what everybody wants in retirement.
Michael – Yeah, that’s what everybody wants, right? So here we go. We’re looking at Vanguard and we’re looking at ABC, same average 8% return. So if you do the math, you’re thinking, okay, let’s see we’re gonna average 8% return, and we’re gonna take out four actually work out pretty well, shouldn’t it?
Zach – Sure.
Michael – Well, here’s the deal, in that Vanguard portfolio. Here we go. It’s December you open up your, I’m sorry, January again you’re opening up the statement, same thing. You open up your statement. You’ve gotten that 40,000 a year, it’s been growing over time. You look at your statement you know how much money you have, $314,000. It’s like, how is that possible? I averaged more than I took out, because losses hurt you more than gains help you. Meanwhile, your next door neighbor Bob got his statement, right? You both been retired 20 years. He gets his statement. He’s got $2 million. 2 million in fact, more than 2 million. I’m gonna say it again. Losses hurt you more than gains help you. What did my dad say? Protect principle, take some income, and if possible grow it. You both earned the same rate of return. Did Vanguard, did they protect your principle and grow it? No way your million went down to 300,000. In fact, you better not live too much longer because you’re gonna run out of money. Meanwhile, at ABC, this company we’ve never heard of got the same rate of return but did they protect principle? Did they take income Did they grow it? You bet they did. So understanding what your variance is on a portfolio is super important. You need to know what that is and if you’re a client, Hey, good news. We already got that under control for you. But if you’re not, if you wanna reach out and have us just run a little portfolio audit we can look at your portfolio. We can tell you, Hey, which of these two portfolios does yours look more like? Does it look more like the Vanguard approach? Does it look more like ABC’s approach? What is your money look like? And Zach all they gotta do is give us a call, right?
Zach – That’s right, yep. You can give us a call here at our office, 512-886-5850. Or you can go to our website, iwanttoretirewell.com.
Michael – And if they’re really feeling like they’re online just super awesome people. Can’t they go to some talk to Mike thing?
Zach – They can, and it goes straight to our calendar where you can just book a time for us to give you a call. It’s easy. It takes like 30 seconds, not even.
Michael – So what is it? Talktomike.com?
Zach – You got it. Talk to Mike, M I K e.com. It goes straight to the calendar. You pick a day, you pick a time that works for you. All we need is a name and a phone number, and we’ll give you a call.
Michael – 15 minute call and so that’s the thing based on this conversation if you’re just sitting there and you’re thinking to yourself, Oh my goodness. I wonder what my portfolio looks like. And you might think you’re diversified. I can’t tell you how many times people say they come and say, Oh, I’m diversified, I’m good. We run their analysis and they find out, Oh, maybe you’re not as diversified as you thought you were. You actually have something that looks like that Vanguard approach. And so it’s important that you find that out, especially now because markets are really high levels. It’s a great time to do a check. So go to talktomike.com, set up a time to talk or give us a call, email, website, whatever works for you. But with that, I think we’re good today. Don’t you Zach?
Zach – I think so. Any final thoughts before we sign off?
Michael – Yeah, I think retirement should be the best time of your life. I think that it’s important that you enjoy the three Cs. You should have a great, you should feel as though you are in control of your finances and your taxes. You should feel confident that you’re making the right financial decisions. And you should feel that comfort, that peace of mind that no matter what the markets bring whatever the tax code brings, at least financially you’re gonna be in great shape. Make great decisions and you’ll get there. And that’s the purpose of all these messages that we share. So with that, I hope you enjoy the rest of your week. So take care everybody.