Strategies for recovering from financial loss
When people lose money in the stock market, wait too long to start saving, lose their jobs, or get divorced, many of them assume they can never recover financially. They also assume that they will never be able to have the same lifestyle as before the setback. And some of them take unnecessary financial risks in an effort to recover. I encourage people to look at their situation in a different way. There are effective strategies we can use to help you recover from financial losses.
Unprotected wealth erodes over time
Taxes, inflation, and increases in consumption can erode substantial amounts of wealth if we don’t counteract them strategically. In our work with doctors, dentists and business owners, more often than not, the more money they make, the more they consume and pay in taxes. After years of this cycle, people often wonder why they are not moving forward.
I can’t help you get back the money you’ve lost, but I can help you create a strategy using the assets you currently have to prevent taxes, debt, inflation, and “style creep.” lifestyle” to erode your potential for wealth creation. And then, when you retire, your assets will be spent as if you hadn’t lost any money. Every dollar you lose has a negative rate of return of 100%. Getting that money back through effective strategies gives you a positive rate of return.
Three strategies to help you keep more of your money
Here are three strategies we use with our clients to help protect their wealth from erosion, ensure their wealth building strategies work better over time, and dissolve the fear and indecision that can cost them valuable financial growth opportunities.
1. Be a world-class saver
Saving enough money can be difficult. Many people save 5% or less of their gross income and hope that high rates of return in the market will compensate for a low savings rate. I recommend increasing this rate to at least 15% and becoming a world class saver. With a higher savings rate, you can reduce your risk in the market and end up with a lot more wealth over a period of time – and be more confident along the way.
If you’re struggling to increase your savings rate, some technology tools can help transform the way you think about saving. When these tools are properly implemented, you can turn your first dollar of income into savings and then allocate future increases in income to savings rather than having those increases go to personal consumption.
2. Be Strategic About Asset Location
Financial advisors talk a lot about asset allocation — an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio based on the investor’s risk tolerance, goals and investment schedule investor. I believe it is equally important to pay attention to asset location — investing your money is an asset that receives different types of tax treatment. The higher your income and tax bracket, the greater the tax-efficient investment.
The tax structure of the assets you invest in matters, largely because of the time value of money (TVOM or TVM). According to this basic financial concept, your money is worth more now than it will be in the future. This is because if you receive money now, you can invest it and potentially earn a rate of return over time; you cannot benefit from this growth if you were to receive the money at a later date. If you invest in assets that generate taxes along the way, you will lose the opportunity to invest the dollars paid in taxes and allow them to grow.
Compound interest is sometimes called “the eighth wonder of the world”. But that’s not true in a taxable environment. The following points help to explain this concept:
A. If you invest your money in a tax-advantaged (tax-exempt) account such as a Roth Individual Retirement Account (IRA), a Roth 401(k), or a Roth 403(b), you will have to pay taxes on all contributions. you pay the account in advance; however, the money grows sheltered from income tax and exits sheltered from income tax in the future. Contribution limits prevent you from investing all your money in such accounts.
B On the other hand, if you invest the money in a taxable account, like a traditional brokerage account, you’ll pay taxes along the way when you earn interest or dividends or realize capital gains when you sell an investment that increases in value. Typically, investors pay these taxes from an account other than the investment account. When you withdraw money from another account to pay taxes, you will not only lose that money, but what that money could have earned you at a given TTOM rate. This number can be substantial.
VS And finally, if you put that money in a tax-deferred account, like a traditional 401(k) or 403(b) account or an IRA, you’ll get a tax deduction today, and you won’t pay any tax on the money until you withdraw it. However, when you withdraw it, you will pay taxes on the withdrawals regardless of the ordinary income tax at that time.
For example, suppose you plan to invest a lump sum of $100,000, you have a time horizon of 25 years, your tax rate is 40%, and you will earn 5% interest on this investment. Here is a comparison of the three different types of taxation and the results. As you can see, under these simple assumptions, all accounts have the same balance after 25 years, but the differences are significant. While the tax-exempt account has no tax, the tax-deferred has a tax liability of $94,545 that ultimately must be paid, and, because the taxable account had to pay taxes each year, this investor lost the opportunity to earn 5% rate of return on taxes paid over 25 years. The taxes paid plus the money lost at 5% amounts to more than $169,000.
Always consult your financial advisor about the tax consequences of your investment decisions. One wrong move could make a significant difference in your net worth over time.
3. Consider permanent life insurance
I am a strong believer in life insurance. Having large amounts of life insurance in place when you’re young will help protect your family from financial hardship if you die unexpectedly. Yet, there are so many more possibilities to use it as part of an overall strategy for lifelong protection and wealth accumulation. Permanent life insurance can be a powerful solution for your needs by providing a death benefit in addition to a potentially valuable asset in your portfolio. Unlike Roth IRA or Roth 401(k) plans, there is no income limit on how much you can contribute. This can be particularly appealing to people in a high income tax bracket.
There are many life insurance policy design options and strategies that are beyond the scope of this article. Yet, it is important to understand that having a well-designed policy, especially whole life insurance, that lasts forever can produce multiple lifetime benefits that protect and increase wealth. Here are a few :
- The money comes in after tax, grows tax free and, if used correctly, comes out tax free.
- Unlike taxable accounts, there is no loss of wealth due to TVOM costs.
- Depending on the state you live in, the cash value of a life insurance policy may be protected from creditors.
- The policy’s cash value acts as a buffer asset during periods of high volatility, so you don’t have to dip into assets in a down market.
- The existence of a permanent death benefit acts as a “license” in retirement to spend assets instead of living on interest alone.
This last point is especially important when you understand how much cash flow increases when you can spend the principal and interest on your assets. This helps free you from the “4% rule” (a general rule that you can comfortably withdraw 4% of your savings in your first year of retirement, and then adjust that amount for inflation for each subsequent year without risking running out of money for at least 30 years) while potentially allowing you to leave a legacy for those you love most.
Most people use traditional financial theories and conventional wisdom in an effort to protect their hard-earned money. But my theory is, “If you do what everyone else does, you’ll get what everyone else has.” That’s why, at our firm, we consider your complete financial situation and focus first on financial protection. It’s never too late to start recovering from a loss — and it’s never too early to start maximizing your wealth-building potential.