Saturday, February 19, 2011

An Easy Way to Lose Three Million Dollars

Let’s say you were given a list of ten options where each option netted in the loss of $3,000,000.00. If you had to choose from that list the option that you thought most people would choose as the most unlikely way to lose $3,000,000.00, which one would you pick?

1.) Leave the Lottery Ticket line to go to the restroom, only to find that you missed buying the winning ticket.

2.) Spend an extra $15,000.00 on a car at age 20. Instead of buying the $20,000.00 model, you opted for getting the supped up $35,000.00 model. (Assuming you retire at age 65, if the $15,000.00 was invested and left to grow for 45 years at a 12% rate of return then you would have $3,233,203.96 at retirement.)

3.) Cause a catastrophic accident without having any insurance.

4.) Borrow $3,000,000.00 from your rich Texas uncle to start a business and end up losing it all in three years.

5.) Start smoking at age 16 and continue until age 30 (14 years), then never smoke again. (Assuming your smoking habit cost you $130.00 per month for the 14 years, if you would have invested that $130.00 a month for 14 years at a 10% rate of return you would have $47,687.32. Then if you left that $47,687.32 alone for 35 years working at a 12% rate of return, you would have $3,114,570.16 by the time you retired.)

6.) Have a “Mystery Thriller” you wrote make millions for the person to whom you gave it to, because the top publishers in the country told you it was worthless.

7.) Spend $12,000.00 at age 18 for one year of college, then quit and never return. (I am definitely not promoting not going to college, but had you instead invested that $12,000.00 for 47 years at a 12% rate of return, you would have accumulated $3,284,248.87 by retirement.)

8.) Fully fund a “Guaranteed” IRA at a Bank starting at age 25 until retirement. (By “Fully Funding” an IRA, I mean investing the maximum allowable for the year, which is currently $5,000.00 per year or around $416.00 a month. Since we are assuming retirement at 65 then this would be for 40 years.)

9.) Never work a day in your life.

10.) Win the “Mega-Millions” Jackpot and then blow it all in Las Vegas in one week.

Believe it or not, in all ten options, you could stand to lose $3,000,000.00 – some in a very obvious fashion, while others in a not so obvious fashion. Now the million dollar question -- or rather three million dollar question: Which option do you think most people would choose as the least likely way to lose $3,000,000.00?

I know that’s probably a silly question, but I think most people would agree that option number eight would probably be the least likely case for losing $3,000,000.00 much less any money at all. You may be asking yourself, “How could I possibly lose $3,000,000.00 by investing $5,000.00 a year for 40 years into an IRA that is guaranteed down at the bank?” Well, let me show you how easy it actually is:

First of all, you would be lucky nowadays to get a guaranteed 3%, much less 6% rate of return at the bank right now even if you tried. But, let’s give them the benefit of the doubt. Over the last 40 years the banks guaranteed CDs have averaged around a 6% rate of return. If you were to invest that $5,000.00 a year for 40 years (from age 25 to 65 – till your retirement) …
  • at a guaranteed 3% rate of return you would have $388,316.00 at retirement.
  • at a guaranteed 6% rate of return you would have $820,238.00 at retirement.
Now, let’s compare that to skipping the middleman and investing that same amount of money directly into the stock market with mutual funds. Over the last 40 years the stock market has averaged a rate of return over 10%! By investing the same $5,000.00 a year for 40 years …
  • at 9% rate of return you would have $1,841,459.00 at retirement.
  • at 12% rate of return you would have $4,295,712.00 at retirement! The cost of that guarantee at the bank would have cost you $3,475,474.00!!
The reason that this is such an easy $3,000,000.00 mistake to make is because it is just as easy as signing on one dotted line versus signing on another dotted line!

Don’t get me wrong, I am not a bank hater; however, I don’t think banks should be used for investing for the long term. In essence, when you invest down at the bank you are loaning your money to the bank. The bank, in turn, will invest your money at a much greater rate of return than they will agree to pay you. After they take their portion of the profits, they will keep their word and pay you the agreed upon -- “guaranteed” -- lower rate of return. When you invest in the stock market you own your money and you have more control and a much greater probability for getting a higher return.

So, be an owner and not a loaner! My hope for you is that you do not make this $3,000,000.00 mistake! I hope this is helpful.

Here are some additional related articles explaining why it is a mistake to do your investing at the bank:
Also, my Canadian counterpart Stephanie Holmes-Winton of The Money Finder and contributing author to Difusing Debt Blog has written her version of this post in a Canadian's perspective. I would recommend that you read her article titled 7 Ways to Lose a Million Dollars!

I'm so excited to share this information with you. If you have enjoyed the information or feel that it would benefit someone else, please share it. If you have any questions or comments, please feel free to contact me.
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