There is a “financial guru” named Douglas Andrew who lives in my local area. He is a financial planner, radio host and author who advocates a rather unique approach to retirement planning. I’ve occasionally come across his “radio show” on Saturday evenings. It annoys me, because it is composed of several hours of sales without an ounce of real information being provided. He pushes his books, CDs, webinars and seminars which are thinly-disguised solicitations for your financial planning business. Since I couldn’t get anything out of his show, and I surely wasn’t going to spend an evening going to a 3.5 hour sales presentation, I decided to check out one of his books from the library. The book is called Missed Fortune 101 – A Starter Kit To Becoming A Millionaire. In big words under the title is the question, “Isn’t it Time You Became Wealthy?” I said to myself, “It sure is time I became wealthy! I’m going to read this book!”
When I started writing this review, I wasn’t sure how long it was going to be. It ended up being nearly 7000 words long. My only consolation to you, the reader, is that the review is much shorter than the book. In order to preserve your sanity, I’m going to split it into 5 separate posts and run one a day for 5 days. You may decide to quit reading after day 1, but I think if you hang in there you’ll learn a lot more about finances than simply realizing that “Missed Fortune is probably a bad idea for me.” I’ve turned off the comments for each of the first 4 posts, so you’ll have to wait until Friday to weigh in on this discussion. That’ll keep the conversation focused in one place instead of all over the website, and give me a chance to lay it all out before the discussion begins.
The Missed Fortune Financial System
In a nutshell, here is what Douglas Andrew says you should do with your money:
- Step 1: Avoid putting money into 401Ks or IRAs.
- Step 2: Buy 1-2 homes with nothing down.
- Step 3: Use an interest-only mortgage on both properties.
- Step 4: Use all that money you saved by not putting it into 401Ks/IRAs, down payments, or mortgage principal payments and invest it into universal life insurance policies.
Does that sound insane or what? Now, it’s not as bad as it initially sounds, but this plan still has plenty of holes in it big enough to drive a truck through. Here’s his reasoning.
Don’t put money into tax-deferred vehicles because you’ll pay more tax on it later than you’ll save now (half-true). In fact, if you have anything in there now you should pull it out right away even if you have to pay a lot of taxes and penalties to do so. Don’t put anything down and use interest only mortgages because home equity earns a zero percent return (not true), is not liquid, and is subject to loss in the event of foreclosure. If you have home equity, pull it out as soon as possible. Then buy multiple universal life insurance policies because it’s tax-free going in (not true by the way), it grows tax-free, it earns similar returns to other investments (not exactly true), it comes out tax-free, and when you die it “blossoms” into even more money thanks to the death benefit. He basically recommends you “arbitrage” your money by borrowing at a lower, tax-deductible (mortgage) rate and invest at a higher, tax-free rate (inside the life insurance policy.) If you don’t see all the flaws in his reasoning yet, (the parenthesized comments may help) don’t worry, I’ll be going through them all in detail.
Safety, Liquidity, and Rate of Return
Doug spends a lot of time in his book and on the radio (and I’m sure in the seminars) talking about how good investments have safety, liquidity, and a solid rate of return. The fact is, however, that you don’t necessarily need all three of these from each of your investments. For example, I don’t need the money I’m planning to spend in 20-50 years to be liquid. Sorry. If it takes me 5 years to liquidate it, that’s okay. There’s plenty of time. But I do need that money to have a decent rate of return so I can grow the nest egg despite the effects of inflation. With regards to my emergency fund, I need it both safe and liquid. However it is a relatively small percentage of my net worth, and I can live without it having any kind of decent return. Sure, if someone wants to pay me 20% on my E-fund, I’ll take it, but I certainly don’t expect or need a good rate of return on that little chunk of money.
Marginal Tax Rates Vs. Effective Tax Rates
Mr. Andrew doesn’t seem to get (or chooses to ignore) the concept of effective tax rates. In every example in the book, he considers 401K/IRA withdrawals to be taxed at an effective rate of 33%. The truth is that the vast majority of Americans will pay an effective tax rate on 401K withdrawals that is far less than 33%. Even most doctors and other highly-paid professionals will have a lower rate. I’ve explained this before on the blog, but in retirement, just like when you’re working, you first subtract your exemptions and deductions from your income. So for a married couple in 2013, the first $20,000 of income is completely tax-free. Your next $17,850 is taxed at only 10% (federal) and the next $54,650 is taxed at only 15% (federal.) So your first $92,500 in income is taxed at an effective rate of only 10.8%. A required minimum distribution at age 70 is 3.6%. If 3.6% of your nest egg is $92,500, we’re talking about an IRA of $2.5 Million. What kind of an income does it take to get there in 30 years or so if you’re saving say 10% of your income into the IRA? About $360K per year. That means your 401K contributions would be taxed at 33% if you weren’t putting them into the 401K. Contributing at 33% and pulling out at 10.8% is a winning formula.
The astute critic will note that the IRA withdrawal rate could be higher if you are getting other taxable income, such as Social Security. But even assuming that you get $30K (maximum of 85% taxable) of that $92,500 from Social Security, you’re still only looking at an effective tax rate on that IRA withdrawal of 14%, far less than the 25-33% you saved while making the contribution.
This simple misunderstanding by Douglas Andrew causes him to make incorrect assumptions that lead to incorrect conclusions throughout the book. But wait! There’s more. Unfortunately, you’ll have to come back tomorrow to get it. Here’s the link to part 2.