The smartest investors I know don’t worry about asking what may seem like stupid questions.
After all, putting your hard-earned dollars into an investment isn’t the same as simply stashing it away in a checking or savings account. There are risks involved, and you should know what you’re getting for your money.
Sometimes, when you hear an investment will earn a certain rate of return — whether it’s 5% or 6% or even 10% — you aren’t necessarily getting the whole picture. You need to be prepared to challenge that number and to ask questions that will determine the true bottom line.
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For instance, if you’re told an investment will get you a 5% return on your money, you might think it means that if you put in $100,000, at the end of the year you���ll have $105,000. Seems like simple math. But what if the financial professional proposing that product charges an annual fee of 1.5%? Then the net to you is really only 3.5%. And what if the investment has an internal fee? Then your net is even less.
The first question you should ask is, “What’s the net to me?” Or, to be more specific, “What will I actually end up with at the end of the year if I do this?”
The second question you should ask is whether an investment is giving you a return on your money or a return of your money. The wording is subtle, but there’s a difference.
Recently, I had some clients come in — we’ll call them Mary and John — and they told me about a “great” investment they were considering.
It would guarantee them 7% growth every year for the next 10 years, which meant their $100,000 investment would just about double to $200,000. After those 10 years, they would receive $10,000 a year in income for the rest of their lives.
The 7% growth sounded wonderful to them. The thought of doubling their money in 10 years was certainly appealing — as was the idea that they’d get $10,000 a year for life, guaranteed.
But I had questions about the real return for this investment.
Mary and John are both 65 years old. Hopefully, they will live a good long time — at least to the average age of about 85 to 87. But even if they do, after 10 years of getting income, from age 75 to 85, they will have only gotten back their own money — their original $100,000 investment. After 20 years — 10 years of growing the money and 10 years of taking income — the actual return would be zero. And that’s only if they live that long.
Now, let’s say one or both of them should live to 95, and they actually end up getting the full $200,000 in income over the years. Yes, they did double their original investment, but it will have taken 30 years, not 10.
Doubling your money in 30 years is a 2.4% return. Not terrible for a low-risk investment. But not “great.”
With that information in hand, John and Mary potentially could make a better decision about the benefits of this particular investment versus others they might want to consider. It took a closer examination to understand the complete picture.
“Return” is a tricky word in the financial world. Don’t be reluctant to ask a trusted adviser — preferably a retirement professional — to do the math with you, to break it down for you, and to help you understand every option you should consider as a part of your retirement plan.
Kim Franke-Folstad contributed to this article.
Investment advice offered through JCG Investments, LLC. (JCG), an independent registered investment advisory firm. Securities transactions for JCG are placed through TDAmeritrade, Fidelity, and Trust Company of America. Insurance and Annuity products are offered through Monolith Financial Group, Inc. Licensed California Insurance Agent #0777322
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