Eroding Factor #1: Taxes

Taxes help our government to run, therefore, there is nothing we can do to avoid paying tax because we know that we will always have a government. When tax law first began the top tax bracket was only 7%. Today, it sits at 35%, and its likely that will go up in the years to come. Aside from paying federal taxes, we pay state, city, and even local taxes. Believe it or not, it doesn’t stop there. The everyday goods that we purchase we pay a tax on, also known as sales tax. Do you own a home or car? You guessed it. Taxed. Every year. Ever heard of Social Security? You pay tax on that, too. After taxes, you have had about half of your income eroded away.

So let’s do a quick review. We pay taxes on money that is coming in to us, and we pay tax on the money that is leaving us to purchase goods. Where does it stop? Not there.

Benjamin Franklin once said, “In this world nothing can be said to be certain, except death and taxes.” Mr. Franklin is quite smart. In fact, when you die both of them are combined. Who would have thought? You don’t even have to receive or dish money out to pay taxes! When you die, something called an estate tax is created. Estate taxes are taxes imposed by federal or state government on property transferred from the deceased to the living.

Taxes erode our wealth faster than any other of the eroding factors, but is certainly not all that affects our bottom line. Stay tuned for the rest of the nine wealth eroding factors.

Eroding Factor #2: Inflation

How many of us remember our parents or grandparents telling us stories of when they used to go to the baseball games and get a hot dog and a drink for around fifty cents back in the day? Today that same ball game plus hot dog and a drink would easily cost you fifty dollars, unless you’re going to a game at Yankee Stadium or Fenway Park. Then it might cost you about ten times that amount.

So what exactly is inflation? As you may have guessed from the story above, inflation is the progressive increase in the price of the everyday goods and services that we purchase. In other words, every year your dollar will buy less than it did the year before. With the average annual inflation rate of about 3%, your one dollar cup of coffee will only buy a .97 cup of coffee the next year. Let’s look at this from another angle. You have $10,000 in your savings account that you plan on leaving for ten years. In ten years, the future value of your $10,000 is only $7,374.24. You’ve lost just over 26% on your money just by letting it sit over a ten year period.

Eroding Factors #3 and 4: Technological Change and Planned Obsolescence

I got my first cell phone for my birthday about nine years ago. I remember thinking how great it was that I could finally talk to other people while I was out of the house. What a great improvement in technology. Now, nine years later, I would never have thought that I would be checking my email and using the Internet from my phone. Technology is improving everyday, and at a rapid pace.

With these advances in technology we are constantly purchasing new goods or services to improve our lifestyles, make our jobs easier or more efficient, or quite frankly, to keep up with the Joneses. The point is, we purchase these things every year, whether we have an immediate need for them or not. This is a trend that will likely be a part of our lifestyle year after year.

When compared with technological change, planned obsolescence is very similar in nature. Every product that you will ever buy will have a certain life span attached to it. When this life span is completed, you have a need to go out and buy a replacement for that product. This is called planned obsolescence. The producers of these products create these goods keeping in mind that once a product becomes obsolete, the consumer will come back to purchase another product.

Although these three money eroding factors may seem small when compared to the effect taxes have on your wealth, they can be quite significant when added together in an individual’s bottom line. Stay tuned for the next six money eroding factors.

Eroding Factor #5: Financial Expenses

Financial institutions don’t charge you money to keep your money with them, right? WRONG! We pay fees, advisors make commissions off of your money, and there always seems to be some kind of charge for anything you do within an institution.

We understand that there are some fees that we just can’t avoid, but more often than not we aren’t evaluating whether or not its worth paying fees for some of the financial products or services that we use. For example, many financial advisors charge a fee to meet with clients, and they have every right to. However, when a client comes to an advisor to invest $10,000 and the advisor charges $3,000 for a consultation, the said client is already 30% down on their investment. Kind of backwards, don’t you think?

Eroding Factor #6: Lost Opportunity Cost

Our same client that we mentioned earlier also experienced another eroding factor after being charged a consultation fee by his advisor. Its called lost opportunity cost. This is a commonly overlooked factor when it comes to people and their money, however, it is vital to understand when it comes to your financial planning.

What opportunities are you missing out on? The opportunity to make more money. Our client that was charged $3,000 in our discussion above can never make any money on that money again. It is lost, hence, lost opportunity cost. Let’s look at what our friend has lost. Assume that the client was to put his $3,000 into an account for twenty years that would have earned 6% every year. That same amount of money would have grown to $9,621.41! That’s over three times the amount of his original investment. Instead, the opportunity was lost on a fee. Let’s take that a step further. What if the client had to pay this same fee every year he had an annual review with his advisor? Our client doesn’t just lose $60,000 in fees, but he also loses the interest he would have earned on that amount over time. The lost opportunity cost comes out to $116,978.18! That’s half the cost of a decent home! Maybe our friend will think before he pays those kind of fees again.

There are many things that cause us have lost opportunity cost. How many of you have car or homeowner’s insurance? How many of you have never had a claim on either of those insuance policies? If you’re blessed enough to not have had a claim, then you have lost all of those premiums over time. Don’t get me wrong, I’m not saying that insurance is a bad thing. Its a very good and very powerful tool that is necessary in every financial plan.

The point is that we lose many opportunities to make the most of our money. Some are avoidable and some are unavoidable. We need to do our best to avoid unnecessary spending on financial products and to find places that will best meet our financial goals.

Stay tuned for part four of our money eroding factors next week.

Eroding Factor #7: Decline in Interest Rates

When an individual deposits money into a bank they are essentially giving the bank a loan. In turn the bank pays that person interest for lending them their money. I’m sure that many of us have put money into a savings account or CD in the last couple years. What has happened to interest rates during that time? They’ve fallen. Hard. What was once around 5% a couple years ago is now lucky to be 2%. In fact, most would be lucky if their interest rate has been earning more than the inflation rate.

Am I saying that saving money in a bank is a bad thing? Of course not. In order to build wealth you must actually learn to save. However, if you’re banking, no pun intended, on that money growing rapidly, it’s simply not going to happen. This decline has made it difficult for a lot of older folks, even those who are retired, to get a decent return on their money. They are hoping to supplement their income with additional savings during retirement, but these lower interest rates are not allowing them to do so.

Eroding Factor #8: Decline in the Stock Market

This factor has probably been a more difficult pill to swallow. Most individuals are quite aware of this factor having experienced it in the last year. How many people have lost anywhere from 30-50% of their retirement income? A lot of us have. Here’s a statistic: for those of you that have lost 50% of your account values in the last year, it will take seven years to earn back the amount that was lost. By the way, you must earn at least 10% each year during those seven years to be where you were.

Again, am I saying that you should stay away from the stock market? No. The stock market can be very effective in an person’s financial plan, but only with money that they can afford to lose, retirement or not. A good thing to remember is that risk does not always equal high return. It often can mean the opposite, as we’ve recently seen.

I hope that today’s discussion didn’t bring back too painful of memories for those affected by these eroding factors. Our next discussion will cover the last two money eroding factors. Until next time.

Eroding Factor #9: Loans and Interest

In an ideal world, we would hope that we are earning more interest than we are paying out. Are we seeing that today? Let me put it this way, if you know of any savings vehicle that will earn more interest than than the interest being paid on any type of of lending product give me a call. Let me take you back to a time when there were interest rates around 15%. Sounds pretty good, right? Sure it does, but you were also paying about the same rate for your mortgage. Times sure have changed. The point is, we need to minimize the payment of excess interest if at all possible. The point of building wealth is earning money, not paying it out.

Eroding Factor #10: Lawsuits

Probably the most over looked factor, lawsuits can be devastating to a person’s financial plan. Lawsuits can erode away assets faster than any of the other eroding factors if they ever occur. The only way to minimize the effects of this money eroder is to fully protect yourself with the correct types of insurance.

Here’s an example of the effects of a lawsuit. Someone I know well was involved in an auto accident. It wasn’t anything major, rather was just a fender bender. A year and a half later, this person was served papers for a lawsuit that had been filed against him. The person that was rear ended had claimed whiplash and won the lawsuit for $500,000. Now, had the person being sued not had the correct protection his assets would have been the first to be seized.

We never know when something of this magnitude will happen. We must do our best to be fully protected against anything and everything that could erode our assets away. I hope that we have helped to make you more aware of the factors that erode your money. Thank you for reading and stay tuned for many other financial topics that affect all of us in today’s society.