In reality, this is only true with certainty if you are neither saving nor spending money. Most people save money toward retirement so they can spend it in retirement. Does this sound like you? If so, a higher compound return (even over long periods of time) does not necessarily create more wealth for you.

The reason a higher return may not produce more wealth is due to another variable called “timing risk,” which applies to every investor who is either saving or spending money…probably like you. Here is a simple example of how a higher return can produce less wealth.

Let’s say you are saving $10,000 at the beginning of each year for the next five years to achieve a spending goal. Assume we have a time machine so we know in advance what the return and risk will be for two investments…“A” will produce a 9.62% return with higher risk and “B” will produce a 13.43% return with lower risk. Which would you pick, “A” or “B”?

Without knowing what the returns will be in each year, knowing the five year compound return is of no help.

Because “A” produced higher returns in later years after more money had been saved, the lower returning “A” ended up producing nearly 27% more profit. No one knows when different returns will occur, but clearly a significantly higher compound return can produce significantly less wealth.

To learn more and see an 80-year study using actual historical returns, read our whitepaper, Measuring Temperature with a Ruler.

While some of your retirement income will invariably come from dividends and interest, focusing only on “yield” may needlessly sacrifice your lifestyle.

Dollars of dividends don’t spend any differently than dollars of gains, or dollars of principal for that matter. And, in the case of interest, like high yield (junk) and foreign bonds, a dollar of interest may actually spend less than a capital gain because of higher ordinary income tax rates.

To learn more, read these two articles on Forbes:

Beware of Yield Bribery

Myth Busting: Should You Seek Yield for Retirement?

Insurance companies are not benevolent donors of wealth, and they invest in the same capital markets that you can invest in. All insurance products are priced so that the insurance company will profit at the expense of a majority of the buyers of their products. In many cases, it is better to by-pass the high expenses of the insurance company middle man and design your own retirement income annuity.

To learn more, read How Much is that Guarantee in the Window?

In reality, the opposite might be true. What is inside the slices is what matters since many “asset classes” are really just pieces of other asset classes.

Learn more with this article on Forbes:

Fake Diversification:  Does Asset Allocation Work?

Also read this article: Is One Better Than Three?

Star ratings really just measure past risk adjusted return. You cannot go back in time to achieve those past returns. Past performance already happened and cannot be changed. It is like reading yesterday’s newspaper or going to the doctor after you are already dead! Hopefully you recognize past performance is not an indication of future results. The reason this statement is required is because it is true!

Even Morningstar’s Director of Fund Research, Russel Kinnel, was quoted in the Wall Street Journal in August of 2010 as saying, “Fees have proven to be the strongest predictor out there.”  

But being inferior predictors than fees is not the only problem with star ratings. That’s because they are based on “peer groups.”

In the summer of 2011 for example, the S&P 500 Large Value ETF (IVE) fell at the 100^th percentile for the past ten years. This supposedly means every active manager beat the index he was investing in! If the peer group was constructed well, this would be mathematically impossible. All you need to do is to look at the large growth ETF to see the irony.

The S&P500 Large Growth ETF (IVW) fell at the top 1 percentile, meaning the index beat all of the managers over the same period! This is the exact opposite, and this too would be mathematically impossible in a true group of peers.

All this tells us is that peer groups are very misleading. The top 10% of funds get five stars. In the period when the large growth ETF bested all of the active managers, you could have five star funds that underperformed their index.

This depends on the advisor and the firm. The conflicts of interest that exist in the industry are extensive. Commissions are an obvious conflict of interest. Even advisors who are fee based and are supposed to act as fiduciaries often have conflicts of interest that are outlined in their disclosure documents, which far too few people read.

Every aspect of financial services has conflicts of interest, so the consumer is really only hearing one side of the story. Whether you deal with a bank trust department, discount broker, financial planner, stock broker, insurance agent, or money manager, you need to be informed of the questions to ask to protect yourself. We are consumer advocates, and that is why our CEO wrote Stop the Investing Rip-Off!  Learn more here.

The reality is that the majority of 401(k) plans charge higher expenses than what you could otherwise pay in your own personal IRA.

This problem has been so significant that the Department of Labor finally released new fee disclosure rules becoming effective in September, 2012. Unfortunately, the new regulations do not really make it much easier for you to figure out what you are really paying.

See the impact of excess fees in the article, The Other Millionaire You Make and learn more about the “Retirement Rip-Off” here.

Time is certainly an important variable to consider in setting your asset allocation, but it is just one of the multiple variables that are needed to calculate the most appropriate asset allocation for you. If your allocation is based only on time, it is almost certain to be wrong.

Other variables to consider, which “Target Date” or “Lifecycle” funds completely ignore, and are often even more important than time are:

• Current Assets Accumulated
• Planned Savings
• Desired Retirement Spending
• Other Sources of Retirement Income (SSI, inheritance, pensions, etc.)
• Estate Goals
• Risk Tolerance
• Travel Goals

Target Date funds are marketed as an easy way to set your allocation, but unfortunately they make it easy to set the wrong allocation because they ignore so many other factors that are equally important.

This extensive whitepaper examines eighty years of actual historical returns for some example investors and demonstrates that “age based” investing is rarely the right solution:  Measuring Temperature with a Ruler

Setting your risk exposure based on your tolerance for investment risk subjects many investors to needless risk they could otherwise avoid.

Think about it. The basic premise of identifying your maximum risk tolerance is to identify how much pain (risk) you are willing to bear and proceed to position you in a portfolio designed to experience it!

Isn’t risk something we naturally want to avoid if possible? Shouldn’t we at least examine if we can confidently exceed your valued goals with a portfolio with less risk? Shouldn’t we examine if the price to future goals is inconsequential with a less risky portfolio? That is exactly what we do with the Wealthcare System.

See an example of how the whole process works, including taking less risk than your risk tolerance, in this brief presentation.

That might be true. But, if it is possible to be saving too little, mathematically it must also be possible to be saving too much. When is the last time your advisor told you that?

Your savings should be based on your goals and priorities, not a rule of thumb, or even worse, what would be forced upon you by an algorithm.

Has your advisor ever even asked you how much you might like to reduce how much you are saving each year to enjoy your life more now? How could you craft meaningful advice for a client without knowing the answer to this question?

Wealthcare is based on the goals and priorities that you personally value. To see an example of sample clients who were advised to REDUCE how much they are saving each year, open this short presentation that outlines the whole process, including reducing savings.

Did you know that such funds pay an ongoing annual fee to your discount broker OUT OF YOUR INVESTMENTS? Many investors pay hundreds of dollars a year in such programs to avoid a one-time transaction cost.

For example, a no load, no transaction fee S&P 500 “Select List” index fund (PEOPX) on one discount broker’s platform has an expense ratio of 0.51% annually. On a $50,000 investment, the expenses are $255 a year.

On the same platform, another S&P 500 index fund (FUSEX) is available with an expense ratio of just 0.10%, one fifth of the cost, or $50 annually for a $50,000 investment. BUT, the “discount” broker will charge you a $76 transaction fee ONCE, to buy this fund.

It is pretty simple that $76 dollars once and $50 a year ongoing is a lot cheaper than $255 a year.

(If you are wondering why the transaction fee is so high when they normally charge around $8-$12 for online trades, we can only speculate that it is to encourage you to use their firm’s proprietary S&P 500 index fund, which has the same expense ratio as the lower cost fund. Another possibility would be to make up for some of the ongoing 20-40 basis points the broker earns each year from other funds on its no load, no transaction fee platform.)

In reality, the opposite could be true because overly conservative market return assumptions may encourage you to take more risk than needed.  It is important for assumptions to not be overly optimistic (too uncertain) or too conservative (which results in needless sacrifice to your lifestyle, or excessive risk).

Setting appropriate assumptions is often very haphazard in the industry. We have two extensive papers (written for financial advisors) that outline how to construct reasonable assumptions for planning purposes.

To make the most of your life, avoid assumptions that are overly aggressive AND overly conservative.

Learn more with these whitepapers:

Are You Modeling What You Intended?

Hunting for Black Swans

While most advisors do access some unbiased information, in reality, most advisors are inundated with biased and conflicted information from wholesalers, product vendors and even product departments in their own firm.

Few advisors really have the time to go back and skeptically research all of the information they receive. We know this based on the number of advisors we have helped to realize how they have been misled.

Think about all of the commonly held myths we expose here for their invalidity. Finding the truth behind the information is the only way we can confidently help our clients achieve their valued goals. We don’t have product departments or receive any sales fees or commissions from investments we recommend.  We are just one unified firm “Client Department.” The importance of those goals in our clients’ lives is what brings meaning to our careers.  

Track records are what happened to other people’s money…not YOURS. Track records can often be nothing other than a misleading sales pitch to advisors, and in the end, to their clients.

Statistically, ten years doesn’t prove anything other than what already happened. It is uncertain whether the results were due to luck or skill AND whether it will continue in the future.

Since the future is uncertain, perhaps the best way to think about this is to think about a roulette wheel (an appropriate example for the gambles made on track records).

Pretend that you observe the results of ten spins of a roulette wheel, but unlike a real roulette wheel, you don’t know what numbers are on this wheel (like the future uncertainty of the future returns) or even how many numbers are on the wheel.

Could you identify what numbers are on the wheel just by looking at the result of ten spins? Of course not, and you can’t identify investment skill in ten years either.