However, if you want to develop true financial independence, and be in a position to make rational decisions about your future based on fact, then you have to first determine your level of Retirement Bucket™ Dependence.

In a previous blog, we discussed two couples, both age 65.  As a refresher, here’s what we know about them:

Each couple has $1 million dollars in investments in their Retirement Bucket™, the same social security retirement income, and the same pensions.

John and Mary Independent have no mortgage or home equity line of credit, and have recently completed many of the major upgrades to their home, i.e. a new roof, vinyl siding, a new furnace, and new bathrooms.  They have always lived a very modest lifestyle with little or no debt.

Ron and Rose Reactionary still have $260,000 outstanding on a second mortgage they took out to pay for their kids’ college tuitions and weddings, and a condo down in Florida they bought a few years back.  They both drive high end cars.  And, while their home is very nice, after 29 years, it’s starting to look “tired” and could use some upgrades.

The obvious difference between the two couples is the COST of their lifestyle.

Ron and Rose’s lifestyle is much more expensive.  The key is knowing just how expensive so we can determine your level Retirement Bucket™ Dependence.

And, that’s the first step in The Relaxing Retirement Formula™ that we’re going to tackle today.

How Much Does Your Lifestyle Cost?

As unexciting as the task appears, the first step toward you realizing your Relaxing Retirement is for you to have a clear handle on what it costs you to live exactly the way you want!

If you don’t know, I can guarantee, from 22 years of experience working hands-on with so many of you, that you will have unnecessary anxiety for the rest of your life and “pull your punches” by restricting your spending because you don’t know if you have enough.

Or, you will continue to work because you think you “have” to, when in fact you may not “have” to.

So, the first step toward a relaxing retirement is to have a clear handle on what it costs you to support your desired lifestyle.

As I mentioned, I recognize that this may not be the most pleasant exercise you’ve ever been through.  However, it’s the key to reducing your anxiety level.

Do I Now Have To Live On a Budget?

Before we delve into the best way to calculate your level of Retirement Bucket Dependence, I want you to know that this is NOT about living on a “budget” and restricting your spending.

This is about having an “accounting” of what it costs you to live the way you want so that you can have a measuring stick to make decisions.

There’s a big difference.

How to Carve Up Your Spending into Bite-Sized Chunks

There are two major categories of ways that you spend your money.  The first is the typically bigger, one-time expenses, like renovating your kitchen or bathroom, landscaping projects, paying for your children’s wedding (hopefully only once), or purchasing a car, etc.

Think about the next five years.  Is there anything you’d really like to do that would fall into this category?  Write down your wish list right now, and then rank them in order of priority.

You want to know right now what you’re going to need to spend money on, not five years from now when you “suddenly” need the money.

Fixed and Discretionary Expenses That Repeat

Once you’ve done this, you can jump to the other category of spending; those which repeat themselves year after year.  And, under this category, there are some which are “fixed” or mandatory, and some which are “discretionary” (your choice based on your priorities).

Typical “fixed” expenses include utilities, insurances, groceries, clothing (at least most clothing falls under this category), mortgages, real estate taxes, etc.  These are expenses that must be paid, and typically they’re paid every month.

“Discretionary” spending, on the other hand, is where we’d like to spend all of our money!  However, when planning, most people don’t account for them as much as they should.  Things like vacations, presents for your grandkids, meals out, and entertaining, etc.

Remember, this is all about living exactly the way you want, so you want to be generous with your estimates.  If you guess too low, you’re only shortchanging yourself.

Looking Forward

Once you’ve identified precisely what it costs you to support the lifestyle you want, we now want to see what your spending looks like, not just today, but many years into the future.

And, when we talk about the future, we have to talk about INFLATION because what costs a dollar today certainly won’t cost a dollar ten years from now.

When you project your spending into the future, you have to build in a conservative inflation figure (the amount by which your expenses will go up each and every year on the same goods and services you currently purchase right now).

For example, if inflation averages a mere 3%, that $100 worth of groceries you just picked up will cost you $135 in ten years.  And, this only assumes a 3% inflation rate.

To be more realistic and conservative in your planning, I recommend that you build in a higher inflation figure.  That’s not being negative.  It’s being realistic, especially in light of the massive amount of debt financing being used by our federal government right now.

The Next Step

Once you have this information in your hands and you have your own unique set of numbers, you’re well on your way to enjoying a relaxing retirement where you’re not dependent on the income from work to support your lifestyle.

In our next blog entry, we’re going to delve into the next step of The Relaxing Retirement Formula™, and determine your level of Retirement Bucket Dependence so you can identify how much you can confidently spend.

And, that’s what it’s all about.  You want to be able to confidently live exactly the way you want without worrying if you’re going to run out of money.

When you’re in a state of fear and unrest, how easy is it to relax and enjoy yourself?

Not very easy at all.

Specific to money, which is the means with which we all support our desired lifestyle, developing and maintaining supreme financial confidence is more necessary and critical today than ever before.

Without it, you will continue to pull your punches, thus not living the life and enjoying the experiences you could and should out of fear.

Or, you’ll continue to work believing that you have to when facts may support the opposite.

A Financial Confidence Deficit

Have you ever stopped to think about why a lack of financial confidence is so pervasive today?

Well, to begin with, there’s no long history, and very few good examples, of individuals who have reached and maintained financial independence over a long life.

You have to remember that, for anyone other than the super wealthy, the whole concept of retirement, or being able to financially support yourself without having to work, has only been around for about 70 years.

Historically speaking, that’s not a very long time.

Before that, “retirement” didn’t exist.  People worked until they passed away.  Or, they lived with, and were supported by, their family.

What initially changed all of that was social security and fixed monthly pensions provided by lifetime employers.

It was a lot easier for most because you could add up the amount you’d receive each month from social security and your pension, and if it was more than you needed to live on, you could make the determination if you’d be okay or not.

However, over the last 30 years or so, that has all changed.  Fixed pensions are becoming a thing of the past for most Americans.

Instead, employer sponsored “savings” plans, such as 401(k)s and 403(b)s have taken center stage as employers look to remove themselves from the financial management business.

At retirement, you’re no longer ‘guaranteed’ a monthly payout.  Instead, you’re presented with a lump sum of money and it’s your job to determine:

a) First, is it enough to provide the lifestyle sustaining income I’ll need given inflation?

b) And, second, how do I avoid all of the potential mistakes, and take advantage of the opportunities necessary for me to earn what I need in order to make my money last longer than I do?

So, in a nutshell, at a time where there is no room for big mistakes, the responsibility for your financial independence and security has been transferred from your employer to you.

100%!

Generating consistent cash flow…. navigating ever changing tax laws… managing investments and dealing with volatile financial markets… protecting your income and assets for your family… planning your estate.

It’s now all on you.

And, on top of it all, you are pounded on a moment by moment basis through various media outlets tugging at your attention with conflicting and confusing information.

No Mystery

There’s no mystery why there is such a lack of financial confidence out there!

It’s no wonder why only 6% of Americans reach financial independence and 94% do not!

In essence, this is why we created The Relaxing Retirement Coaching Program™:

The Relaxing Retirement Formula™

As we begin the New Year, I believe it’s critically important for you to review and implement the fundamentals and principles of what a Relaxing Retirement entails.

That begins by taking a giant step back and accurately assessing what the fundamental problems and obstacles are that you’re dealing with.

The focus of many of the individuals who I meet with for the first time is often in many different directions. My recommendation is always to have them clearly identify the lifestyle they want, and then the problems and obstacles they face in getting there.

Let me give you an example:

Problem #1: “I don’t want to depend on the income from work anymore, so I need to generate income some other way.”

Problem #2: “My lifestyle costs a lot more than my pension and social security incomes bring in. (i.e. I need $100,000 per year to live after paying income taxes and my pension and social security only bring in $50,000)”

Problem #3: “I need to create income from my retirement savings to support my lifestyle.”

Problem #4: “I don’t have enough money saved to let it sit in CDs at the bank and earn only 1 to 2%.”

Problem #5: “I need to earn better investment returns to keep pace with inflation so I don’t run out of money.”

Problem #6: “In order to achieve the better returns I need, I have to position my retirement savings where it has an opportunity to earn better returns.”

Problem #7: “Positioning my retirement savings where they have an opportunity to earn better returns subjects me to greater amounts of investment volatility.”

Problem #8: “If my retirement savings run out too soon, I have to either make cutbacks in my lifestyle, or I have to go back to work!”

This may seem obvious, but most people who I meet with for the first time have no idea why they’re even investing in the first place, nor why they’re allocated the way they are.

In most cases, the reason they’re allocated the way they are is because Fund X seemed like a good fund!

Extremely dangerous in its simplicity!

If you don’t begin by first identifying all the potential obstacles in your way to enjoying a Relaxing Retirement, you will join the overwhelming majority of Americans who tend to wander and focus on things that are potentially important, but completely out of context and inappropriate for their unique situation and circumstances.

Stay tuned next week as we dive into The Relaxing Retirement Formula™ to help you stay on track for the lifestyle you’ve worked so hard for and  deserve to experience.

I strongly recommend that you settle in for a few minutes to read them because I think this article is as important as any I’ve shared with you this year.

The first is an Associated Press story that was recently released:

BOOMER BUST—Poll: Anxiety About Retirement Grows

By Jennifer Kerr—Associated Press

Wednesday, Nov. 9, 2011— So much for kicking back at the lake house, long afternoons of golf or pretty much anything baby boomers had dreamed about in retirement. For many, the plan now calls for logging more hours at the office and renewed worries about money, according to a new poll.

The AP-LifeGoesStrong.com poll found a baby boom generation planning to work into retirement years — with 73 percent planning to work past retirement, up from 67 percent this spring.

A majority of boomers also are shaky about their nest eggs. In all, 53 percent of boomers polled said they do not feel confident they’ll be able to afford a comfortable retirement. That’s up from 44 percent who were concerned about retirement finances in March.

“I’m not confident at all,” says 63-year-old Susan Webb of West Liberty, Iowa.

Webb — one of the 77 million boomers born between 1946 and 1964 — had long hoped to retire at 65 from her job as a real estate broker. Not anymore, not since the economic downturn that led to depressed housing prices, wild stock market swings and an unemployment rate hovering at or above 9 percent for all but two months since May 2009.

Webb and her husband, who’s 67, are both still working full time. They hope to ratchet back to part time at some point, but plans for a scenic lake house where they can go fishing and spend time with their two grandchildren will likely mean selling their current home — not part of the original plan.

At 50, Cheri Hubbs of Norfolk, Va., is on the younger side of the boomer spectrum. Even so, she knows she’ll work in retirement.

“I just feel like I’m going to work until the day I die,” says Hubbs, an administrative assistant.

Hubbs had little saved for retirement when she went to see a financial planner a few years ago. Now, she and her husband are socking away as much money as they can. She’s also cut back drastically on her little luxuries — trips to the nail salon and Starbucks.

In the poll, 41 percent of boomers said they are expecting to have to scale back their lifestyle in some way in retirement and 31 percent believe they will struggle financially.

Retirement expert Olivia Mitchell says working longer and cutting back are two practical ways for boomers to save more.

“It’s a kind of downscaled consumer society that I see in the next five years at least,” said Mitchell, a professor at the University of Pennsylvania’s Wharton School and executive director of the Pension Research Council. “Consume less and tighten the belt.”

Downsizing is part of the plan for software designer Greg Schmidt of Carlisle, Mass.

Schmidt, 53, says there’s no doubt he’ll be working longer, likely into his 70s. With a daughter in high school and twin 12-year-old boys, he’s got college tuitions to worry about as well as an aging father and father-in-law.

He plans one day to move to a smaller home, maybe in the mountains of Vermont. Almost one-quarter of boomers in the poll — 23 percent — said retirement will mean they’ll have to move.

For Schmidt, the stock market is another source of anxiety. “I am most concerned that we’re going to be entering a different time and equities aren’t quite as valued,” he said. “I am afraid I’m a little heavy into equities.”

The span between the two AP-LifeGoesStrong.com polls coincided with a 10 percent drop in the Dow Jones industrial average, which recovered most of those losses by climbing this week to above 12,000 before plunging again Wednesday amid concerns about Europe’s debt crisis.

In all, 62 percent of the boomers polled lost money on at least one of four core parts of retirement savings:

—A workplace retirement savings plan, 42 percent.

—Personal investments outside of an IRA/workplace savings, 41 percent.

—An IRA, 32 percent.

—Real estate, 29 percent.

The AP-LifeGoesStrong.com poll was conducted Oct. 5-12 by Knowledge Networks of Palo Alto, Calif. It involved online interviews with 1,095 baby boomers, as well as companion interviews with an additional 315 adults of other age groups.

Story #2

If you haven’t been tempted to jump off a tall building yet after reading that, let’s compare and contrast the next piece of news. And, this is an expanded answer to the November Relaxing Retirement Quiz:

Quiz Question: What is the average “intra year” percentage decline in the stock market? (i.e. over the course of any given year, what is the average peak to trough drop that occurs during the year?)

Answer: 14%

A great example of this was last year in 2010: the S&P 500 Index began the year at 1,115. It roared to 1,217 by April 23^rd. It then dropped to 1,022 on July 2^nd (a 16% decline), only to then rise up again to finish the year at 1,258.

Had you taken a nap in your hammock all year long, you would have witnessed a price increase of the S&P 500 Index of 12.8%.

However, had you been living through it on a day to day basis, you would have also experienced a 16% peak to trough drop in the middle of it in order to realize and benefit from that 12.8% rise!

I chose to use this quiz question this month because it’s an incredible statistic to embed into your subconscious. Always remember that it’s never what happens in the market that matters.

What matters is your response to it. Most Americans continue to be shocked and surprised by what the market is doing because they’re intellectually and emotionally unprepared for it.

So, knowing this piece of information, there are two responses when confronted with a 14% drop in market prices like you recently witnessed from April thru September of this year:

Strategy A: “I’ve lost 14% of my money, there’s no end in sight, and I’ll never get it back!”

vs.

Strategy B: “I’m experiencing a perfectly ordinary, unsurprising, and above all temporary correction that represents the average intra-year correction in markets, and it will have no lasting effect on my long term returns.”

I know this is a rather simplistic set of choices. However, I think there’s a lesson in there for all of us.

And, that is the history of volatility. The more we know about it, i.e. it’s frequency and depth, but also its long term harmlessness, the less likely we are to be surprised by it.

The less likely we are to get panicked by it, and the less likely we are to react in ways that we intuitively know are not the right thing to do if we’re thinking rationally.

A Little Contrast

Before we contrast these two “stories”, I’d like to share with you the lens through which I view information like this. It all stems from the book Psychocybernetics, by Dr. Maxwell Maltz, which I read for the first time over twenty years ago and strongly, strongly recommend to you and your family.

Since then, I’ve tried to let it be the governing thought process of everything I do and everything I share with you in our program.

When asked by a reporter to clarify the essence of his research and teaching (since the title is somewhat intimidating and unclear), here was Dr. Maltz’s answer:

The essence is the accurate, calm, and ultimately automatic separation of fact from fiction, fact from opinion, actual circumstance from magnified obstacle, so that our actions and reactions are solidly based on truth, not on our own or others’ opinions.

Before reading on, I recommend reading that a few more times and giving it significant thought. (I’ve had this posted next to my desk for years as a constant reminder).

I’m sharing this with you because you’re at a critical and precarious juncture in your life right now.

Critical because after relying on the income from work to support you for the majority of your life, you’re now relying on what you’ve saved along the way to support you for the remainder of your life. A tall task by anyone’s standard of measurement.

And, precarious because there are virtually no guarantees anymore.

So, developing and maintaining your financial confidence on a daily basis is not something that we can just give lip service to anymore. It’s of paramount importance if you want to live the remainder of your life the way you deserve to live, and without the constant fear of running out of money.

Associated Press Story

With the constant development and maintenance of your financial confidence as a primary lifelong goal, and Dr. Maltz’s recommended strategy as a means to get there, let’s now go back and take a closer look at the AP story (from page one) which appeared in hundreds of major newspapers across the country. While there is so much that we could talk about, let’s focus on just a few quotes from the story that I’d like you to re-examine:

“So much for kicking back at the lake house, long afternoons of golf or pretty much anything baby boomers had dreamed about in retirement. For many, the plan now calls for logging more hours at the office and renewed worries about money….”

Is this a fact or opinion? Is it fact or magnified obstacle?

“I’m not confident at all,” says 63-year-old Susan Webb of West Liberty, Iowa. She had long hoped to retire at 65 from her job as a real estate broker. Not anymore, not since the economic downturn that led to depressed housing prices, wild stock market swings and an unemployment rate hovering at or above 9 percent for all but two months since May 2009.”

I feel for Mrs. Webb, but I wonder how much planning she and her husband have done up until now. I run the risk of coming across as cold hearted here, but “depressed” housing prices, wild stock market swings, or high unemployment should have little or no impact on her prospects for retirement if she’s planned properly up until now. This is a classic example of the media’s desire to tug at your heartstrings in an effort to create a “story”.

“It’s a kind of downscaled consumer society that I see in the next five years at least,” said Mitchell, a professor at the University of Pennsylvania’s Wharton School and executive director of the Pension Research Council. “Consume less and tighten the belt.”

Is this fact or opinion? Clearly an opinion, yet a statement that will resonate with the majority of Americans who unconsciously derive their confidence (or lack thereof) from so-called “expert’s” opinions instead of facts.

“Schmidt, 53, says there’s no doubt he’ll be working longer, likely into his 70s. With a daughter in high school and twin 12-year-old boys, he’s got college tuitions to worry about as well as an aging father and father-in-law.”

Now, Mr. Schmidt’s situation (kids’ tuitions and aging parents) is a fact. But, it’s not a new phenomenon or historical tragedy that has suddenly been dropped into his lap that should now derail all of his carefully laid out plans up until now.

Without putting this story through a filter like Dr. Maltz’s, after reading it, you’re likely to come away with the feeling that your life is completely out of your control.

The world’s “horrible set of circumstances” have you under lock and key, and there’s no hope whatsoever for a better future. Life will only be more and more difficult, and your means of survival are for you to “consume less and tighten the belt.”

Relaxing Retirement Quiz

If you’ve survived all of that pain and misery, let’s move on to story #2 which is simply an answer to a question: What is the average “intra year” percentage decline in the stock market? (i.e. over the course of any given year, what is the average peak to trough drop that occurs during the year?) Answer: 14%

Now, that’s a quantifiable fact that your actions and reactions can be solidly based on.

And, given this fact, your choice of reactions when market prices again drop 14% in any given year can be:

“I’ve lost 14% of my money, there’s no end in sight, and I’ll never get it back!”

or

“I’m experiencing a perfectly ordinary, unsurprising, and above all temporary correction that represents the average intra-year correction in markets, and it will have no lasting effect on my long term returns.”

Do you see the difference? And, can you see how critically important it is for you to use Dr. Maltz’s litmus test in order to protect your financial confidence in today’s world?

I can’t stress enough how important this is. It’s the reason why I decided to devote this entire article to it after first reading that AP story.

I know what you’re up against, and it’s not easy. In today’s second by second, sensationalistic news (and opinion) reporting in all forms of media (television, radio, newspapers, magazines, on-line, etc.), it’s extremely difficult to determine what’s fact vs. opinion or magnified obstacle, sort it all out, put it in perspective, and remain confident.

Yet, at the same time, I also know how critically important your financial confidence is. In many respects, next to your physical health, the quality of your life can be measured in direct proportion to it.

That’s why I continue to make it the focal point of The Relaxing Retirement Coaching Program™, and why I will continue to point out and crystallize these important distinctions.

Keep your antennae up! Protect your financial confidence, and ultimately the quality of your life.

By harvesting, I mean utilizing any unused capital losses that you’ve realized in prior years, and potentially this year, to save yourself a bundle in taxes.

As painful as realizing a capital loss is, the great news is you can recover a significant portion of your losses if handled properly.

Unfortunately, most retirees do no planning whatsoever and just pay whatever their accountant tells them to pay.

Let’s quickly review capital gains tax law for a moment so we can clarify where this opportunity lies for you.

Capital Gains Tax Law

As a refresher, for investments you currently own outside of IRAs (you don’t pay capital gains when you buy and sell investments inside your IRA), all “realized” gains are taxed at capital gains tax rates.

For example, if you purchased a stock or stock mutual fund for $50,000 and later sold it for $75,000, you would owe capital gains taxes on the growth, i.e. $25,000.

On the flip side, however, if you purchased a stock or stock mutual fund for $50,000 and later sold it for $40,000, you can declare a capital loss of $10,000.

That $10,000 capital loss, while painful to realize, has significant value if handled properly. For example:

1. You may use it to offset $10,000 of capital gains you realized in the same year, thus eliminating taxes on $10,000 of capital gains. This saves the average taxpayer a minimum of $1,500 in federal taxes, not to mention state taxes here in Massachusetts.
2. If you don’t have $10,000 of capital gains to offset, you can use $3,000 of the loss to offset $3,000 of ordinary income you have this year. That would save the average taxpayer approximately $750.
3. You can then carry the unused portion ($7,000) over to next year and continue the same strategy. If you have a $7,000 gain next year, you can offset the entire tax due. If not, you can offset another $3,000 of ordinary income tax and carry the remaining $4,000 over to the following year.

Opportunity

Had you sold any investments during the downturn in 2008/2009, thus locking in and ‘realizing’ a capital loss, you now have the opportunity to recover some of your losses.

Or, if you have any investments held outside of IRAs that are currently in the red since you purchased them, you have an opportunity to lock in a capital loss right now and use it against your realized gains this year.

Mutual Funds Held Outside of IRAs

Even more important, however, are stock mutual funds you own outside of IRAs.

By law, mutual funds must pass on all realized gains to their shareholders at the close of each year.

If you’ve owned stock mutual funds for several years, you know what I’m referring to. You may have had to pay significant taxes in the past, even if you didn’t sell any funds!

You receive a 1099 in the mail from the mutual fund company informing you that you have thousands of dollars of capital gains that you must report to the IRS, even though you didn’t make any sales.

This event is likely to occur with many equity funds this year.

The good news for you is that you can now put those painful capital losses from back in 2008/2009 to work for you to save yourself a bunch of taxes.

Strategy

My recommendation for you is three-fold:

1. Pull out your 2010 federal income tax return. Take a look at the bottom of Schedule D to determine if you have any unused capital losses carrying forward into this year. And, if so, how much?
2. Take a look at your realized and unrealized gain/loss positions in your non-IRA account statements.
   1. Have you already realized some gains in 2011 that you’ll want to offset with losses you carried forward from 2008 or 2009?
   2. Do you have any stocks or stock mutual funds that you’ve thought about selling, but haven’t pulled the trigger because it will carry a large capital gains tax with it?
3. If you own stock mutual funds, go to your fund company(s) website and you will typically find year-end “internal” capital gains distribution estimates. Do your best to determine what your short and long term gains will look like.

Once you’re armed with this information, look for opportunities to offset this year’s gains with either prior losses you’ve carried forward, or with losses you could “realize” this year by selling specific holdings.

Harvesting is a critical year end strategy which you can’t afford to let pass you by. The difference could be thousands of dollars of tax savings in April.

A few years ago, Relaxing Retirement member Bob Weston shared this with me and I really liked it.

Enjoy this…

The Mayonnaise Jar and Two Cups of Coffee

When things in your life seem almost too much to handle. When 24 hours in a day are not enough, remember the mayonnaise jar and 2 cups of coffee.

A professor stood before his philosophy class and he had some items in front of him. When the class began, he picked up a very large and empty mayonnaise jar and proceeded to fill it with golf balls.

He then asked the students if the jar was full.

They agreed that it was.

The professor then picked up a box of pebbles and poured them into a jar. He shook the jar gently. The pebbles rolled into the open areas between the golf balls.

He then asked the students if the jar was full, and they agreed it was.

The professor next picked up a box of sand and poured it into the jar. Of course, the sand filled up everything else.

He asked once more if the jar was full. The students responded with a unanimous “yes”.

The professor then produced two cups of coffee from under the table and poured the entire contents into the jar effectively filling the empty space between the sand.

The students laughed!

“Now,” said the professor as the laughter subsided. “I want you to recognize that this jar represents your life. The golf balls are the important things—your family, your children, your health, your friends, and your favorite passions—and if everything else was lost, and only they remained, your life would still be full.”

“The pebbles are the other things that matter like your job, your house, and your car.”

“The sand is everything else…the small stuff. If you put the sand into the jar first,” he continued, “there is no room for the pebbles or the golf balls.”

“The same goes for your life. If you spend all your time and energy on the small stuff, you will never have room for the things that are important to you.”

“Pay attention to the things that are critical to your happiness. Play with your children. Take time to get medical checkups. Take your spouse out to dinner.”

“Play another 18. There will always be time to clean the house and fix the disposal.”

“Take care of the golf balls first—the things that really matter. Set your priorities. The rest is just sand.”

One of the students raised her hand and inquired what the coffee represented. The professor smiled.

“I’m glad you asked. It just goes to show you that no matter how full your life may seem, there’s always room for a couple of cups of coffee with a friend.”

***

Well said!

As we reflect on Thanksgiving, take a minute and write down what your golf balls and pebbles are.

It’s never too late to re-prioritize.

The good news of them having enough financial resources to comfortably retire right now was, unfortunately, overshadowed by the bad news.

And, that bad news as that if they continued to invest the same way they had, their financial resources would run out in 7 to 9 years.

Now, that may seem like a contradiction, but it’s not.

They do have the resources, but their Retirement Resource Forecasters™ that we use to design their Retirement Blueprint™ has some assumptions built into them, as all forecasts do.

One of those assumptions was that their investments had to earn 1.5% above the rate of inflation. Historically, this has been accomplished without taking huge risks and subjecting yourself to massive volatility. Long term inflation and market performance statistics spell that out clearly.

However, given Gary and Barbara’s actions (as illustrated in their last three years of investment statements that they brought in when we first met last month), it’s extremely unlikely that they’ll be able to accomplish this.

The reason I had to reveal this piece of bad news with Gary and Barbara was the 2011 Dalbar, Inc. research that I shared with you last month.

To refresh your memory, here’s what their study on the results for the 20 year period ending in December, 2010 revealed

• The Average annual return of the S&P 500 Stock Market Index from 1991 thru 2010 was 9.14% (including dividends reinvested)
• However, the average annual return of the “average” equity mutual fund investor (not investment, but an investor, i.e. a person) over the same 20 year period was 3.83%
• The Average annual return of the Barclays Aggregate Bond Index from 1991 thru 2010 was 6.89%
• However, the average annual return of the “average” bond mutual fund investor (not investment, but an investor, i.e. a person) over the same 20 year period was 1.01% (a difference of 85.3% per year).

What these numbers tell us is that, while the S&P 500 Market Index delivered a strong average annual return over those 20 years of 9.14%, the average stock mutual fund investor (a person, not an investment) only achieved 3.83%!

That means that the average equity investor’s return was 58.1% less than the broad market index each and every year!

Unfortunately, it’s no better with bond investors. The average bond fund investor earned 85.3% less (each year) than he or she could have earned doing nothing but buying an index fund and watching from the sidelines.

How incredible is that?

What Can We Learn From This?

What you can’t help but take away from those statistics is that, while it makes all the news, markets or bad investments are not our biggest problem. Far from it.

The big problem is investor behavior which is driven by their “strategy” or lack thereof.

Forget for a moment about trying to “beat the market” which is what is talked about in all investment forums today.

The average stock mutual fund investor earned 58.1% less each and every year than the S&P 500 market index (a market barometer of “average” returns, not above average)!

In the bond category, it’s even worse. The average bond fund investor earned 85.3% less every year!

Think about that for a moment. Something that we all can control is what our biggest problem is.

I recognize that I’m repeating myself, but I’m doing so to emphasize this critical point.

What Can You Do To Close This Performance Gap?

The first piece of news to share is that there is no ONE reason or one strategy you can use to close this gap.

However, over the last 22 years, there are several “strategic behavioral mistakes” that I’ve personally witnessed that I’d like to share with you that you can instantly employ.

And, these are the biggest reasons why I believe the average investor earned 58% to 85% less than the market averages.

Let’s start today with Reason #1 why I believe this massive performance gap exists: The WRONG “INVESTMENT GOVERNING” ISSUE.

Let me clarify what I mean by “Investment Governing Issue” because it has many important points that I suggest you make a note of.

First, a statistic for you that you may have heard me share with you before: the average retirement age today in America is age 62.

If you are a 62 year old couple (and each of you does NOT smoke), insurance company mortality tables tell us that at least one of you will live to be 92 years of age!

Please take a moment to go back and read that last paragraph before going on.

That means that, if you’re age 62, you’ve got 30 years with which to provide life sustaining income.

30 years!

Not five.

Not ten.

Not even just twenty.

But 30 years!

The Goal: Lifestyle Sustaining Income

By “lifestyle sustaining”, I mean income that keeps your standard of living the same even when prices rise.

Let me put that into perspective for you.

In 1932, a first class stamp cost 3 cents.

In 1971, it was 8 cents.

In 1980, it was 15 cents.

Today, it’s 44 cents!

Not to send a “better” letter, but the same letter.

While there are very few guarantees in life, one that I believe we can prudently count on is the fact that life will continue to get more and more and more expensive.

As I just illustrated, he price to mail the exact same letter costs you three times what it did just 30 years ago.

That’s extremely instructive given the 30 year lifespan of a 62 year old retiring couple.

Protecting Principal vs. Protecting Purchasing Power

Now, here’s the problem from an investment standpoint…what is the dominant governing issue among the overwhelming majority of retirees?

Protecting Principal!

If there’s a loss that everyone tends to focus on managing, this is it. Above all else, “we have to protect our principal.”

And, this governs their investment decisions.

Well, in reality, the biggest financial issue, as I’ve just illustrated, is the protection of your “purchasing power”, or your ability to sustain the same standard of living.

This has nothing to do with wanting “more” for yourself.

It’s about sustaining the same lifestyle.

Even if inflation is only 3% over the next 30 years, and I would strenuously caution you against using that low of a number, but even if it is only 3%, you’ll need $2.44 (2 dollars and 44 cents) to pay for the same goods and services that the dollar in your pocket pays for right now.

That means that if groceries currently cost you $100 per week, they’ll cost $244 for the exact same groceries.

Again, this is not a bonus to protect your purchasing power.

It’s a bare necessity! Yet, the overwhelming majority of retirees have as their #1 goal to protect their principal, when in fact it has to be the protection of their lifestyle sustaining income.

I can’t stress enough how important it is to clearly distinguish between those two goals if you want your hard earned money to be there for you for the rest of your life.

Stay tuned as I’ll reveal the 2nd biggest reason for the horrific performance gap of the average retiree, and what you can do about it right now.

As you’ve heard me say before, after experiencing markets like this with our Relaxing Retirement members over the last 22 years, I know just how troubling all of this bad news is to deal with, especially when you’re at the stage in your life where you’re dependent on the money you’ve saved to support you, as opposed to relying on the income from the work you do.

I know how challenging it is to remain confident when the overwhelming majority of voices you hear are delivering sour reports and forecasts.

It’s not easy, and it’s not fun.

Meaningful Specifics

Back in the financial crisis of 2008-2009, one of our Relaxing Retirement members asked me in passing how I personally deal with problems, crises, challenges, etc.

It’s a very good question that led to an extremely valuable discussion which I’d like to share with you given our current climate as I believe it will really help you.

Before I reveal this to you, I want to alert you ahead of time that there are both psychological and practical strategies in what in what I recommend for you.

I will say ahead of time that I recognize this may appear to delve deeper than necessary (an expanded Retirement Coach Strategy!), and that I run the risk of having you gloss over it.

However, I believe you have to first understand the way the human brain works. I assure you that understanding this is critical to your progress in these difficult times.

We’re All Hard Wired

Studies have shown that the human brain is broken down into three sections: reptilian (back), mammalian (center), and frontal.

The two critical points of understanding for the purpose of our conversation are that the reptilian portion of our brain is our most primitive in that its response mechanism is dictated by “primal instincts”. Essentially, it’s where our “fight” or “flight” reactions come from when we’re faced with danger.

By contrast, our frontal lobe is where all critical thinking takes place, i.e. reason, analysis, prioritizing, rational thought, etc.

Now, what does this have to do with how I personally deal with challenges and what I recommend for you? Answer: Everything

The key point is that when we’re faced with a challenge (danger) like we’re experiencing right now with this current downturn in stock prices, our initial reaction stems from our reptilian primal instinct, i.e. ‘fight or flight’. To overcome this, we have to consciously move beyond this ‘primal instinct’.

Our brain can only deal with specifics. Vague generalities, like what we’re fed every day by the media, do not help us obtain the clarity we need to make rational decisions, and, in turn, develop and maintain the confidence we need. Instead, these vague generalities only serve to paralyze us.

Because of this, my reaction to all challenges is to de-emotionalize myself as quickly as possible in order to place it all in proper perspective. In other words, I don’t let the “reptilian” part of my brain dictate my response in a knee-jerk fashion.

Instead, I consciously write out all of the “perceived” dangers, obstacles, and setbacks in specific detail on a sheet of paper.

I then do whatever is necessary to quantify all of them as they apply to me and those around me so that I can make rational decisions and react with a well thought out plan.

How You Can Use This Today

With current market and financial turmoil, negativity is pervasive. It’s everywhere.

However, each of us has a choice.

We can either engage in the ‘group think’ perpetuated by the media, or we can get specific about what’s really true in your life because your brain can really only deal with and act on specifics.

Let’s take a look at a few “group think” pieces of information and headlines reported by the media that you’ve undoubtedly heard or read over the last week:

• The recently concluded 3rd quarter was the worst market performance since the 1st quarter of 2009.
• The S&P 500 Index is now down 20% from its April high, and 10% in 2011.
• The Russell 2000 Index (small cap) is down 17.8% in 2011.
• Still Hope for the Fourth Quarter
• Gold falls $35 an Ounce as Inflation Fears Wane
• Bernanke Equates “Twist” to Half a Point Rate Cut

The challenge with all of this “information” is that it’s just a bunch of vague generalities. It’s useless in helping you make rational decisions in your own life.

The Alternative: Meaningful Specifics

In contrast, here’s an “example” of meaningful specifics that would help you make rational decisions, and thus help you develop and maintain your level of confidence. Assume for a moment that these facts are your facts:

1. The amount of income you receive from social security and your pensions is $5,000 per month.
2. Your fixed monthly expenses (per your Lifestyle Cost Estimator™) are $6,000 including income taxes.
3. Your discretionary expenses are $5,000 per month in order to live the way they want, including vacations and gifts for your grandchildren.
4. Given this, you need $6,000 ($6,000 fixed plus $5,000 discretionary expenses minus $5,000 of fixed income) per month from your Retirement Bucket™ (your investments) in order to make up the difference.
5. Your investment balances, after this market correction, now total $1,400,000.
6. You’re 68 years of age and want to plan for at least another 22 years until age 90.
7. You’d prefer to live in your current home as long as possible, so you don’t want to “count” the equity in your home in your forecasts. If you had to, you would downsize at some point in your life, but would prefer not to ‘have’ to.
8. The investment rate of return we determined that you needed to earn in order to continue your monthly withdrawals of $6,000 (plus a healthy 5% cost of living increase each year) was 5% back in April.
9. Today, after six more months of withdrawals and the market’s impact on your investment values, you now need to earn 6%.

Given these meaningful specifics, this example illustrates how you would now know exactly where you personally stand in relation to current economic conditions based on your own unique priorities and resources.

This allows you (if you choose to engage in this line of thinking and exercise) to make rational decisions based on relevant facts instead of remaining paralyzed.

It may not provide you with what you might interpret as “good” news. However, it does provide you with facts that you can make decisions with, such as how you choose to position your money from here forward, or how you choose to spend in the future.

Reading the newspaper, turning on the television, and/or checking on-line throughout the day to see where the market is will not provide you with usable information with which you can act.

It only further perpetuates a lack of confidence, and, in turn “paralysis”.

Given the stage in life that you’re experiencing right now where the money you’ve accumulated over all these years must now support you, you have every right to be anxious and frustrated.

However, as I just illustrated, you want to do everything you can to move forward so that you can continue to confidently live the way you want.

Before addressing situations which I believe are an inappropriate uses of annuities, I thought I’d provide you with a couple examples of situations where annuities might be appropriate for you.

Annuitizing

To review, annuitizing means turning your savings into monthly income for a stated period of time, typically for life.

• Covering a Specific Expense: If social security is your only source of guaranteed monthly income, and you have a specific bill that must be paid each and every month, you may want to consider funding an immediate annuity.  Structure the amount of the payment to you to cover that expense for the period of time the expense exists, i.e. a mortgage.
• Medicaid Planning: It would be impossible to cover all the issues concerning qualifying for Medicaid in this issue.  However, in the big picture, if you have assets above a very minimal level, you will not qualify for Medicaid assistance to pay for your care.  One strategy used by many elder law practitioners is to move current assets into an immediate annuity.

In the eyes of the federal government, the asset no longer exists.  Only the income from that asset which significantly increases your chances of qualifying for Medicaid assistance.

However, the same warning that I’ve raised still applies here.  Remember that when you annuitize, you give up access to your money other than receiving your monthly income. When you and/or your beneficiary pass away, the insurance company keeps the money.

• Guaranteed Income: If you want some portion of your monthly income guaranteed, an immediate annuity can accomplish this.

Two caveats come with this, however.  The first I just alluded to which is to remember that once you annuitize, your asset is turned over to the insurance company.

The second is inflation.  With most annuities, the payment is guaranteed for a certain period of time, typically for life.  However, there is no cost of living increase each year to keep pace with inflation.  So, if your monthly payment is $2,000 per month, 10 and 20 years down the road, you’re still going to receive $2,000 per month even if inflation has decreased the value of that $2,000.

Tax Deferral

If you have funds outside of your IRA, Roth IRA, and/or employer sponsored retirement plans that currently earn interest, dividends, and/or capital gains that you’re not currently spending, you may want to consider using an annuity to defer income taxes until you need the money to spend.

There are three potential benefits of doing this:

1. Deferring the Tax: You control ‘when’ you pay the tax.  By doing so, you can benefit from compound interest on the balances that would have gone to taxes if held outside of the annuity.
2. Taxes on Social Security Income: The amount of tax you pay on your social security income is in direct relation to the amount of income you receive in addition to social security.  The lower the amount of your other “provisional” income, the less of your social security income that is subject to tax.If you currently have interest, dividends, and/or capital gains coming from investments which you’re not spending, using an annuity to defer the taxes on those items not only reduces your taxes on that interest, but it may also reduce the amount of tax you must pay on your social security income.
3. Medicare Part B Premiums: Your Medicare Part B premiums you pay are based on the amount of income on your 1040 tax return the prior year.  Like the example above, if you reduce your taxable income, you may qualify to pay a lower Medicare Part B premium.  One tool to reduce your taxable interest, dividend, and capital gain income is a tax deferred annuity.

As I mentioned previously, I don’t believe annuities themselves are bad in and of themselves.  As I just illustrated, used correctly, they can solve real problems.

However, I do believe that many of the situations where annuities are recommended and sold need to be seriously called into question.

Later this month, I’m going to reveal some of them to you.

Gold is a great example of that. Every time the Fed mentions loosening up the money supply, we can count on the “gold folks” to put their marketing in high gear.

Another great example of this is annuities.

Whenever the stock market experiences periods of higher than average volatility, annuities become a hot topic of conversation. Insurance companies and agents are very intelligent to use the opportunity of volatile markets to promote them.

Recently, I’ve received a host of questions on annuities.

As with any financial topic, there is a host of misinformation and what I kindly refer to as “omissions”, specifically by those who are in the business of marketing them.

So, I thought I’d take the opportunity to discuss the pros and cons so that you can independently understand and personally evaluate annuities for your own unique situation.

Preliminary Comments

Before we dig in, just a few preliminary comments…

The first is that an annuity is like any other investment vehicle; they’re a tool to put in your toolbox of potential options.

They’re not a one-size-fits-all solution.

Like any investment, there has to be a very good reason why you would invest in an annuity. Hopefully, that comes after you’ve carefully and strategically designed a Retirement Blueprint™, and after understanding all the facts and ramifications first.

The second point is that, while annuities can be a great option for some to solve a specific problem, I believe they’re grossly oversold.

Given this, my goal is to help you better understand them so that you can make an educated decision for yourself.

What’s an Annuity Anyway?

Let’s begin today by first laying out what an annuity is.

An annuity is simply a savings instrument sponsored by an insurance company.

There are many different classifications and variations, so let’s tackle those first:

Immediate vs. Deferred Annuity

A deferred annuity has two phases to it:

• Accumulation: funds you deposit grow inside the annuity on a tax deferred basis until you withdraw funds.
• Withdrawal or Distribution: you choose how you’d like to withdraw funds from your annuity, either by “annuitizing” the value and receiving a guaranteed monthly payment, or by simply taking withdrawals as you see fit. (more on this in a moment)

An immediate annuity has no accumulation phase. You simply place money into the plan and begin receiving monthly income for life. If you currently receive a monthly pension from your employer, what you’re receiving payments from is typically a form of an immediate annuity that your employer has placed funds in to guarantee your monthly payment.

Accumulation Phase

During the accumulation phase of a deferred annuity, there are two broad options:

Fixed Annuity: When you invest in a fixed vs. a variable annuity, what they’re referring to is the “investment” element. In the case of a fixed annuity, your deposit is credited with interest paid by the insurance company. How much interest you receive is based on the performance of the insurance company who sponsors the annuity, so in that respect, it acts like a CD at the bank. Typically, they come with a minimum guaranteed interest rate for the life of the annuity contract.

Variable Annuity: In a variable annuity, in addition to having a “fixed rate” option to choose from, you are also provided a list of subaccounts which act like mutual funds from various mutual fund companies. There are no guarantees. The performance of your plan will be based on the performance of the underlying subaccounts.

Withdrawal or Distribution Phase

During the withdrawal or distribution phase, there are also two broad options:

Random Withdrawal: When you want to begin receiving money from the plan, the first option, within a deferred annuity only, is to simply take random withdrawals subject to the deferred sales charge limitations set forth by your company. For example, within most companies, you may not withdraw the entire balance of your annuity within the first six to twelve years without paying a surrender charge. However, prior to the end of that period, many companies allow you to take a partial withdrawal without any charge.

Annuitizing (Guaranteed Monthly Payment): When you “annuitize”, you are choosing to receive a guaranteed monthly payment for a period of time, typically for life. In this case, it acts like a pension or the social security income you receive.

• Single Life: When you select the single life option, you choose to receive payments for your life only. When you pass away, even if that’s in three months, the insurance company keeps the money. However, if you live to be 156 years old, the insurance company must continue to pay you the guaranteed monthly check.
• Joint and Survivor or Period Certain: If you have a spouse who you want to protect, or if the prospect of passing away too soon and having the insurance company keep your funds is a problem for you, you may select a joint and survivor or period certain plan. By doing so, you guarantee payments to your beneficiary either for life or for a certain period of time after your death. However, in order to compensate the insurance company for this added risk, you receive a smaller monthly payment while you’re living.

Now that we have the basics down, we’ll continue with a discussion of the pros and cons of using annuities so that you can evaluate them for your own use.

Stay tuned.

What is considered a “gift”?

This may sound like a ridiculously simplistic question, but from a federal estate and gift tax perspective, the definition is very clear.

A gift occurs when you have given something of value to another person or entity with no retention of ownership rights to the gifted item itself.

In other words, a gift is only considered a gift when you no longer have any ownership rights after the gift is given. You may receive benefits from it during your lifetime, such as income, but you no longer own or have any control over the asset itself.

How are gifts taxed?

Just as the federal government has instituted an estate (death) tax on your ability to pass on all of your accumulated assets at your death, they’ve also imposed a tax on your ability to give it away during your lifetime so that you don’t give it all away right before you pass.

And, this tax rate mirrors the estate tax rate, i.e. as high as 45%!

Are all gifts taxed?

During your lifetime, you may give away $1 million without being subject to gift taxes. This is what is known as your lifetime exclusion.

This, however, eats into your estate tax exemption (currently $5 million). If you’ve given away $1 million during your lifetime, that reduces your $5 million estate tax exemption at death dollar for dollar.

The key is that, in addition to this, you may also give away $13,000 each year to anyone or any entity you wish without being subject to gift taxes. A couple could give away $26,000 ($13,000 each).

What if I give away more than $13,000 in one year?

If you give away more than $13,000 to any person in any given year, you are not necessarily subject to gift taxes. The amount over $13,000 simply eats into your lifetime exemption amount of $1 million.

Let’s say, for example, that you give away $100,000 to your son to help him purchase a home. If you have no spouse, then the first $13,000 passes without any gift tax. The remaining $87,000 eats into your $1 million lifetime exemption (and your $5 million exclusion at your death).

In other words, in addition to $13,000 per year, you may now pass on $913,000 during your lifetime without gift taxes.

The way the federal government keeps track of this is through your gift tax return which you must file if you provide a gift in excess of $13,000.

What is the tax rate?

Federal gift tax rates mirror estate tax rates and reach 45% very quickly.

Let me repeat that: 45%. Almost half!

After working and saving your entire life, in addition to paying income and sales taxes, you then have to pay gift and/or estate taxes when you pass away.

Do I pay the tax when I make the gift?

Gift taxes are paid by the giver. So, if you give away money or assets that trigger a tax being due, you would have to file a gift tax return that year and pay the tax.

If you are the recipient, you do not pay gift taxes. And, in most cases, as the recipient, you don’t pay income taxes.

The exception to this is if you receive an appreciated asset such as a stock. If the stock was purchased for $10,000, and it is now worth $100,000, upon the sale of the stock, the recipient would be responsible for paying capital gains taxes, but not gift taxes.

I hope this has been helpful. You may very well want to print this and keep it where you can access it when you need it.