It’s not what you do that counts, it’s what you keep

For high-income Americans, high fees, taxes, modest growth, and inflation are important considerations:

Let’s consider each element:

1. High fees. Tony Robbins in his new book, “Money Master The Game,” explains it well. Mutual funds and advisors often charge a 2% management fee and around 1.25% additional costs. Since most do not outperform for a long period of time, this cost is substantial. Example: If the S&P 500 averages 6.5% over 50 years in an index fund with 0.05% fee expense, $1.00 becomes $30 over 50 years. Netting just 5% after fees, 1.00 goes down to just $10 in 50 years. Considering that half of the profit is from dividends. The higher fees more than offset the dividends.

2. High taxes. If you paid the maximum state and federal taxes each year on your returns, even with a 6.5% return for 50 years, your $1.00 would be worth $6.80. If you deferred taxes on a retirement account and paid the maximum income and estate taxes, your $1.00 would be worth about $6.00.

3. Accepting a low rate of return on your savings guarantees a poor outcome. Consider a 2% net pre-tax return, perhaps 1.4% per year. After 50 years, your $1.00 grows to $2.00.

4. Inflation. The S&P 500 grew about 100% between 2003 and 2013. However, after inflation, purchasing power did not increase. After taxes, these monies actually lost value. Since 1840, the US dollar has lost more than 99% of its purchasing power when we consider the cost of things people need, like food.

Once you consider the issues and quantify them, you can easily do better.

You must invest in a way that provides you with a net positive alpha of the advisory fees. You must follow a disciplined investment process that offers a multiple unit of return for every unit of risk you take. You must be diversified and have a risk control plan for each asset you own. You must take personal responsibility for your money, regardless of who you hire to manage it. The result should be a rate of return that outperforms the market in the long run. This process requires that you learn the rules of the game and be vigilant in protecting your assets from those who make a living from the average investor and not from you. .

You should invest for the long term if your account is taxed to build wealth, but preservation of capital trumps buying and holding during downtrends. The secret is to buy low. You are not a money manager competing quarter by quarter to get larger allocations of money from other people. You can expect opportunities when individual stocks and indices are down. In my opinion, if you only invested when prices were low and held them for several years, your rate of return would be significantly higher than that of the buy-and-hold investor.

To have the required patience, it helps if you have a conservative high-yield tax-free return on your bankable assets. Choosing a high-yield institutional tax-exempt municipal bond fund may fit the bill. The long-term history of high and consistent monthly tax-free income has been very attractive. Even here, you must have a plan in place to control risk during those infrequent periods when the fund may decline substantially. These funds can be purchased institutionally with no commission, no redemption fee, and low management fees. When you make substantial gains on your long-term winning investments, half or all of the income can be added to this account to increase your tax-free monthly income amount.

The magic of compound interest

Compound interest is such a powerful thing that Albert Einstein called it the most important invention in all of human history. Why do so few take advantage of it?

Why do Bill Gates, Warren Buffet and many others create foundations? The following story told in “Money Master the Game” by Tony Robbins will illustrate the point.

When Benjamin Franklin died in 1790, he left $1,000 each to the cities of Boston and Philadelphia. His bequest came with some strings attached: specifically, the money had to be invested and could not be touched for 100 years. At that time, each city could withdraw up to $500,000 for designated public works projects. Any money left in the account could not be touched for another 100 years. Finally, 200 years after Franklin’s death, each city would receive the balance, which in 1990 amounted to $6.5 million, with no money added during all these years.

If this $1,000 were to grow at 8% compounded over 100 years, the principal amount would increase to $2,199,761. If the top taxes were removed each year, it would rise to just $108,674. If the maximum estate taxes were applied at the end of the 100 years, it would only leave about $50,000. Now you know why wealthy people set up foundations for their children and grandchildren to run for years and years.

Ben Franklin got it that way back in 1790.