The Great 401K Experiment and 16 Strategies for Creating Wealth

You have been diligently saving into your 401K looking forward to funding your retirement. You are 57 years old and you open your statement. You’ve lost half of your retirement investment. Suddenly retirement has been pushed back beyond age 65 and you are facing the prospect of having a part-time job when you retire. You have been diligently saving into your 529 college plan. Junior is about to turn 18 and instead of the one hundred thousand dollars you expected based on what you were told were the historic returns of the market, you have less than half of that. Now you have to have the conversation with Junior, valedictorian of his class, about going to the Junior College.

What if the first thing that your financial planner told you after the usual obligatory greeting was that you were about to embark on a great experiment? That experiment would require you to set a consistent amount of money aside for 30 years in a lock box controlled by investment banks and the United States Federal Government, limit your investment options to mutual funds and bonds, and hope that certain beliefs about long term historical returns hold true until you need your money at the end of your working life.

That is exactly the first conversation that I had with my financial planner 7 years ago. She said to me, “Ouida, these mutual funds, 401Ks and 529 college plans…this is all a great experiment Large groups of people have never retired or planned for college in this way before and we won’t know how this experiment is going to turn out for another 10 years or so.”

When I heard that, I thought how silly the television pundits and financial authors are who teach and preach that investors should invest for the long haul and dollar cost average. They simply articulated unproven strategies in an overall experiment that began in the late 1970’s when corporations began to shift the responsibility for retirement planning and pension funding onto employees. I thought about the meaningless conversations that I had with my erstwhile plumber about the latest hot mutual fund and whether or not he should buy Google. The Great 401K Experiment has turned the majority of employees into investors and turned the man on the street or the salesman behind the desk into a financial guru.

Wikipedia defines an experiment in the following manner:
In scientific inquiry, an experiment (Latin: ex- periri, "to try out") is a method of investigating causal relationships among variables. An experiment is a cornerstone of the empirical approach to acquiring data about the world and is used in both natural sciences and social sciences. An experiment can be used to help solve practical problems and to support or negate theoretical assumptions.

I wonder who ever thought that by diligently placing money in their 401K that they were “trying out” their retirement plan?

In scientific inquiry we use an experiment to determine an outcome. As a physician, I rely on the outcomes of well-designed experiments to determine the best therapeutic strategy for my patients. In health care, by the time an experiment involving a therapeutic intervention is carried out on human test subjects, basic assumptions about the therapeutic intervention have already been formulated and tested in the laboratory. In medicine, we know what the variables are and we control for them, we have specific outcome measures and, most importantly, we can stop the experiment if the outcome is out of line with expectations and proves to be harmful to patients.

Despite involving human test subjects, the goings on in the world of finance and retirement planning have nothing to do with a safe controlled experiment. No, in the world of personal finance and retirement planning, we have what is known as an observational study. In an observational study, people participate in a series of activities and we follow them long term to the, uh, end. Whatever that end is. We are simply along for the ride waiting to see what happens. In terms of retirement planning, that could mean a retirement lived in poverty or a retirement in which all of the financial needs are met. But this experiment does not guaranty the latter outcome.

Let’s look at the assumptions that financial planners and employees alike have made:
1) In retirement, expenses will go down. Therefore retirees will need only 75% of their pre-retirement income. This assumption basically means that a person with an annual income of $100,000 during their working years, should set enough aside to generate an annual income of $75, 000 in retirement. This assumption has one basic flaw: it ignores inflation. Current estimates are that retirees will need $250,000 to $300,000 dollars to handle health care expenditures alone. This basic tenet of retirement planning ignores the realities of many retirees, personal illness, the need to care for a sick spouse or adult children.
2) Stock market returns average 8% per year over the long haul. This is simply untrue. A quick trip to moneychimp.com shows that the S&P has returned 8.76% since 1871. However that percentage drops to 6.56% when adjusted for inflation. If you could have been invested in the markets for the past 137 years you could have done okay. But 137 years really does challenge the idea of just what the long haul is. The long haul is certainly more than 10 years. From January 1, 1998 to December 31, 2008 market returns were 0.96%. Inflation-adjusted returns were -1.44%. As I discuss in my article, The Stock Market: The Second Greatest Financial Scam of the 20th Century, the long haul for stocks is more like 30 years. It becomes obvious, then, what you should do if you are 50, intend to retire at 65 and are contemplating putting money in the markets as an investment.
3) Home prices will always go up. This assumption made home ownership tantamount to putting money away monthly into a super-charged savings account. I’ve never seen a savings account lose value the way the housing market did during the Savings and Loan crash and this most recent financial downturn.
4) Capital gains are better than cashflow. The current economic environment is a prime example of what happens when people invest for capital gains alone. When the capital gains party stops wealth is devastated. With cashflow, however, businesses can operate as usual. It is estimated that 20 percent of real estate loans made during the housing boom went to investors. What if all of those investors had invested for cashflow? Price appreciation made cashflow impossible for most of the investor purchases that were made in the last 4 years of the most recent real-estate boom. Absent cash flow, investor money would have remained on the sidelines, fewer loans would have been made, property valuations would have remained in check and part of the speculation that drove the recent housing market would have been absent.


What happens when the basic assumptions of an experiment prove false? The experiment fails. In medicine, a failed experiment sends everyone back to the drawing board looking for answers. Not so in the world of personal finance. Personal Finance is called personal finance for a reason. You are the person and it is your finance. You are the only one who goes back to the drawing board usually with less money than you started with. The broker who sold you the stocks made his money. The fee-only planner that you were told to use by Smart Money Magazine made her money. The fund manager made his money.

What is the solution? Education. Education of the financial type. Every waking minute of every waking day. Yes this is work, but it is the only way. Those who don’t want to do this type of work should remain participants in the observational experiment to whatever end. My financial planner made sure that I stayed out of 529 plans, and that I did not invest in IRAs outside of my 401K plan. The way to wealth is simple and it is the following:
1) Live below your means
2) If housing prices in your area are too high, rent, but aim to keep total housing costs at less than 20% of income
3) Buy a quality car no more often than every 10 years and maintain that car. Car leases and frequent new car purchases are among the greatest drainers of household wealth
4) Eliminate consumer debt.
5) Obtain skills in writing, sales and marketing
6) Save
7) Invest savings into income-producing assets:
a) businesses such as network marketing
b) real-estate
8) Work with those assets once you do invest to make sure they produce income.
9) Protect all assets via entities
10) Find advisors and partners that you can trust who have your interests in mind. They are not hard to find
11) Understand yourself and your tolerance for risk. For many putting money into bonds and not giving financial education another thought is the best strategy.
12) Read a financial book per month and attend one business development seminar per year that teaches a specific skill
13) Stay away from mainstream financial magazines. They only offer the same pabulum that has left many high and dry, stripped of their wealth.
14) Subscribe to Investors Business Daily, The Financial Times or The Wall Street Journal
15) Stay away from personal development seminars but read personal development books
16) Implement the strategies and skills from the seminars and books

Your time investment will be at least 10 hours per week.

Are you ready to invest the time and get going?

Why Won't Someone Just Tell Me What To Do With My Money?

I am sitting here in my office looking over the book titles I have purchased and read over the years. Wealth Cycle Investing, Cash Machine and The Truth About Money are titles that jump out at me. There are many, many others.

Why did I buy those books? Because I, like so many people looking for a way out of financial quick sand, have often just thrown up my hands and wished someone with more brains than me would give me a plan and tell me what to do.

Stephen Greenspan wrote in a recent Wall Street Journal article about financial gullibility. He was swindled by Bernard Madoff. He chalked his gullibility up to financial ignorance and his failure to remedy the situation through financial education. He also outlined social factors that cause us to act contrary to our own financial self-interest. Who is Stephen Greenspan anyway? He is emeritus professor of educational psychology at the University of Connecticut. Oops and oh dear. If he gets swindled with all the tools he has to understand human behavior what about the rest of us? Are we sunk?

I don’t think so. The truth is that no one and I mean no one will care as much about our own personal financial situation than we will. A dear friend of mine used to be an investment banker on Wall Street. She asked me how I was investing my 401K. I said that I was invested in bonds and index funds. She said that that was a good thing because her co-workers who were money managers spent more time managing their own accounts than the accounts of their clients. Humm what a shocker. But isn’t this what the current financial crisis is all about? That money managers, brokers, CEOs, creators of financial instruments were far more worried about their personal bottom lines than the long term implications of their actions in the market place?

What is a person to do? The first thing is to realize that while you may have a trusted financial advisor, that advisor also has mouths to feed and we as a society seem to be a bit beyond the philosophy that payment and compensation should be based on the value one creates in the market place. There has been a giant decoupling of the concept of commissions based on the returns for the investor. Mortgage brokers and realtors were paid based on sales and loans generated for over-priced properties. Now as real estate prices plummet across the country they get to keep their money. Fund managers get to keep their one, two, three, four, five or six percent of assets under management even in a declining market. As a friend of mine recently said, it is a “Yo-Yo”: yo on yo own. One would be well served to realize that it’s a “Yo-Yo” and act accordingly.

Financial planners tell individual investors to consolidate debt by refinancing their homes, to buy and hold, diversify and invest for the long haul. What they neglect to tell individuals is that the long haul is actually a generation. Charles Farrell, an adviser with Denver’s Northstar Investment Advisors, used data from Morningstar’s Ibbotson and Associates to analyze 52 rolling 30-year periods, starting with 1926 to 1955 and ending with 1977 to 2006 “But here’s what’s interesting: The Majority of your wealth would almost always have come in the last 10 years. Mr. Farrell calculates that, on average, you would have notched 8% of your final wealth after the first decade and 32% after the second. In other words, 68% of the total sum accumulated was amassed in the last 10 years.” (Wall Street Journal, Jonathan Clements November 21, 2007); For the investor who invested in mutual funds in 2000 and is asking himself when is he finally going to make money, the answer is probably 2030. Too bad if that investor needed that money in 2010, 2015 or 2020. What about using a home to consolidate debt? Most financial advisors neglect to tell their clients that there is benefit in gaining the skills necessary to eradicate short-term debt. Exchanging short-term debt for long-term debt merely forestalls the problem without addressing the underlying problem for the short-term debt. Lack of skills in debt management simply means that the short-term debt will recur if the reasons for the accumulation of that debt remain unaddressed. From the financial planners’ point of view, consolidation solves their client’s debt problem that is until the debt occurs again. To me the only reason to refinance a house is to free up capital to use for other purposes including gaining the skills to retire short-term debt. Once the debt is retired, the capital can go to other worthwhile financial projects.

Why won’t someone just tell me what to do?

One of the biggest criticisms of financial author Robert Kiyosaki is that he doesn’t give individuals a specific plan to attain financial freedom. He writes, outlining broad concepts, without providing specifics. Robert Kiyosaki does not know each individual’s circumstance, level of financial education or tolerance for risk. How can he simply tell any individual what to do?

Acting the part of the bon vivant, I got a very late start on my financial path and had to make up for lost time. My solution has been to realize first that it is a “Yo-Yo” and to read widely, very widely. Understanding that there is no one size that fits all when it comes to financial matters, I am careful about where I get my financial advice. I was listening to a recent Business Week podcast. The discussion was about credit, the credit markets and ways to protect yourself financially during the current downturn. The correspondent did not even know her credit score when asked. I listened to the podcast, but I certainly wasn’t going to take that correspondent’s advice. I have carved out a plan that works for me. My plan isn’t sexy, it is slow and steady. It isn’t all one strategy, but a combination of strategies gleaned from a few sources. I use free online calculators at bankrate.com and hugh’s calculators to make savings and investment projections. I diligently work my plan. I make mistakes and I blow opportunities but my plan works nonetheless. Yes, I have financial advisors, but the advisors I started out with are not the ones I have today. The advisors I have today have proven over time that they have my interests as well as theirs at heart. I never expect an advisor to throw themselves under the train for my sake but I do expect that if they spy the promised land that they will take my hand and that we will journey there together.

What are the lessons? First, realize that it is a “yo-yo” act accordingly and read widely. Second, financial intelligence is the only remedy for financial ignorance. Third, wealth creation takes time and is not without risk. Fourth develop a plan and work that plan. Fifth, evaluate that plan. Sixth, wealth creation is a team sport so develop your advisors and evaluate those advisors based on the results they get for you. Seventh, as Jesus once said, the poor will always be with you, so understand that whatever is going on in your life that is preventing you from accomplishing steps one through six will always be with you, so the time to start truly is now.

Cashflow: The Only Sensible Investment Strategy for the Twenty-first Century

First the Disclaimer: This is a thought-provoking article that draws upon real world examples, articles, books and websites that are readily available to the public. This article is not intended to offer investment advice. Any actions that you take in the market place should be the result of your own financial education and consultation with a licensed professional.

This is the conclusion of my 3 part series that began with Home Ownership: The Biggest Financial Scam of the Twentieth Century and was followed up by parts one and two of The Stock Market: The Second Biggest Financial Scam of the Twentieth Century.

What is Cashflow? Cashflow simply put is the flow of money. Positive cashflow is the revenue or income that a person receives from a job, investment or business. The majority of people derive their cashflow from their jobs. To the extent that they come to derive cashflow from investments and or businesses is the extent to which they will become financially free when their working years are over. Negative cashflow is the revenue that a person loses due to an investment or business.

Most people are taught to invest for capital gains rather than positive cashflow. Investment success depends on appreciation of the underlying “asset” rather than income production. This is the basis for “investing” in a primary residence or the stock market for wealth creation. Yet, success of the capital gains investment strategy is by no means assured. No one can guaranty that an asset will appreciate in value, despite the tendency to quote historical gains as justification for an investment today. The current housing and market crises highlight the fallacy of depending on capital gains to create wealth. The housing crisis alone will destroy billions of dollars of personal wealth. From the October 25, 2007 Joint Economic Committee report:

The JEC report found that the subprime catastrophe is likely to accelerate the downward spiral of house prices. Based on state-level data, the report estimates that by 2009:
• 2 million foreclosures will occur by the time the riskiest subprime adjustable rate mortgages (ARMs) reset over the course of this year and next.
• Approximately $71 billion in housing wealth will be directly destroyed because each foreclosure reduces the value of a home.
• More than $32 billion dollars in housing wealth will be indirectly destroyed by the spillover effect of foreclosures, which reduce the value of neighboring properties.
• States will lose more than $917 million in property tax revenue as a result of the destruction of housing wealth caused by subprime foreclosures.
• The ten states with the greatest number of estimated foreclosures are California, Florida, Ohio, New York, Michigan, Texas, Illinois, Arizona and Pennsylvania. But there are several others that are close behind in the rankings.
• On top of the losses due to foreclosures, which this report examines, a 10 percent decline in housing prices would lead to a $2.3 trillion economic loss.

The power of positive cashflow is that it guarantees the value of an investment regardless of the markets. Imagine the difference between a real estate investor who bought a house expecting it to go up in value versus the investor who bought for cashflow. The capital gains investor bought at very high premiums in the market such that the rents received for his investment do not cover the expenses. Now the investor must find a buyer who paid more than he did in order to make a profit. If the market goes down that investor will find that he has no staying power and will likely sustain a substantial loss to liquidate the property and limit his on-going monthly losses. The fate of the cashflow investor is much more secure. The positive cashflow yielded by the property will continue regardless of market activity. Should the market go down, the cashflow will continue, giving the investor staying power and continued profits in a down market. More importantly, most if not all of the positive cashflow will be shielded from taxes by depreciation expenses on the property. In short, the cashflow, not the capital gains, on a property will usually be tax-free. Avoidance of unnecessary taxes is one of the best wealth acceleration strategies you can employ. To quote David Swenson from Unconventional Success, “Taxes impair wealth accumulation.”

Cashflow strategies can also be applied to the stock market.

The trouble with cashflow investing is that it requires having a financial education. Cashflow investing requires the ongoing thirst for financial knowledge specific to your chosen area of cashflow generation.

The capital gains strategy encourages financial ignorance. Tempting the would-be investor to treat their investment as a money-in-money out proposition. Actively seeking financial education is the only way that a cashflow investor will be successful. Yet the odds are against him. Not because financial education is difficult to attain, no. The odds are against him because the financial sales people any would-be investor will encounter are paid commissions based on their ability to sell products and the majority of those products are for capital gains rather than cashflow. I find one or two real estate deals per year that yield sufficient positive cashflow for me to consider the deal, yet I am often encouraged by brokers to ignore my criteria for cashflow and invest instead for capital gains.


The cashflow strategy requires that you learn to work with people to form a team and generate profits for all. A capital gains strategy has people so focused on maximum gain that they ultimately succumb to greed, fail to exit an investment at an appropriate time and experience financial loss.

Even in today’s economy cash in the bank is not a source of solace as savers are seeing their returns destroyed by interest-rate-cutting policies of the Federal Reserve. People who depended on interest from savings to provide retirement income are seeing their incomes dissipate as the Federal Reserve sacrifices their incomes to bail out Wall Street, Banks and the derivatives markets.

The actions of the Fed and the behavior of Banks and Wall Street have proven that it is cashflow, not cash that is king.