When I was getting started with my business, a very successful person said to me, “The more money you have, the bigger the mistakes.” At the time, I didn’t completely understand what he meant, but as I began making more and more money, it finally registered.
I grew up in a blue-collar family and was raised to work hard to take responsibility for my life. I have always been driven — it is just part of my DNA — and when you couple a strong work ethic with a desire for nice things, you quickly find yourself stuck.
I was 21 when I began my business, and within a few years, I was making more money than anyone I knew growing up. By all societal standards, I was successful and had all the boxes checked of what many people would perceive as success. I had nice vehicles, a nice home, a model family and was seen as a good, reputable business owner who was involved in the community.
Creating multiple streams of passive income
I always knew that if I worked hard, things would be good, but that was the problem — I had to keep working hard to maintain what I had. Being in finance, I only had examples of how to work hard and make money, but what I eventually figured out on my own was that making a lot of money was not the same as having financial freedom.
I came to realize that what I was doing was unsustainable long term, and I instead needed to create income-producing systems that would support my lifestyle. That was a pivot point in my life when I realized that I needed to create multiple streams of passive income, and so that is what I created for my family.
The experience I had is like so many people who work to earn a paycheck while accumulating money in retirement accounts and then find themselves wanting to retire. They are stuck in the same way I was stuck trying to figure out how to maintain a lifestyle without having to work to earn a paycheck.
Over the last 30 years, I have worked with thousands of people, teaching similar strategies, and have discovered common mistakes that you can work to avoid when possible.
I have come to the opinion that the status quo paradigm about wealth is distorted. The idea of having a high salary or a large investment account as being wealthy is missing the mark. They are both key aspects to building wealth — of course — but, in my experience, wealth is only sustainable when there is passive income. Otherwise, the wealth is limited to your ability to replenish what is consumed.
It is kind of like this: A freshwater spring is more valuable than a stagnant pond because the spring has the potential to provide fresh water for generations, while a stagnant pond must be replenished, or it will go dry.
Money can be spent or lost, but wealth as I am defining it as a source of passive income supports your lifestyle, equating to what is financial freedom.
We have all heard it said: Don’t have all your eggs in one basket. Despite the prevailing wisdom, I find that many people carry around a single basket full of eggs. In my view, there is a misunderstanding of what diversification really means, and despite their best efforts, people often fail to obtain more than a single basket.
For instance, having $250,000 in 10 different banks is diversification of banks, but it is not a diversification of assets. Having a 401(k) and an IRA isn’t diversification of assets if they both hold the same investments. Having a dozen different mutual funds representing different sectors and markets is diversification of a portfolio, but it is not a diversification of the asset.
I find that people often use a narrow view of diversification, limiting their thinking to a single asset type, such as the example of depositing money in several banks. This is what I call vertical diversification, where you go deep into a single asset type but fail to go horizontal to further diversify outside of banks.
A bank account and portfolio of mutual funds would be an example of horizontal diversification in its simplest form. There are two different asset types represented, and within each type, you have vertical diversification. Investments have horizontal types of assets, such as public market, private market and entrepreneurial opportunities that offer vertical diversification within each type.
There are many factors to consider when attempting to diversify, but don’t make the mistake in thinking that a bank account and a portfolio of public investments is all that is available to you. There is more to uncover about how to move your diversification horizontal.
Many people defer tax liabilities on their retirement accounts. The problem that soon follows is the reality that taxes are due when you want to use the money.
Of course, there are times when deferring tax liabilities could be a prudent tax strategy, but those are isolated scenarios, and the motivation is often misinterpreted as a tax savings. Deferring tax is a deferral of tax liabilities and isn’t necessarily saving on taxes.
There is a lot to formulating a tax plan, and it can vary greatly from one person to the next, but a common practice to avoid is making an investment decision based on the tax deduction alone.
Choosing to fund a retirement account over an after-tax account solely for the deduction or a business owner spending money to avoid being taxed are examples of the tail wagging the dog.
When making decisions regarding how you save money, consider how you will ultimately use the money. Most people would prefer having access to tax-free access when they’re ready to use their money.
If you’re already overweighted in tax-deferred assets, a Roth conversion can make sense, but it is best to work with an experienced team of professionals to assist you with finding tax credits or other potential methods that could help you offset the tax liabilities generated from the conversion. If structured properly, this approach can provide a tax-free income in retirement.
Hope is not a strategy, and when it comes to retirement, there is often a “hope” mentality where the investor believes that when there are losses, the markets will recover. We have seen markets move in extreme ways, sometimes good, sometimes bad, but it takes time for a market to recover, and when it comes to retirement income, time is not something you have.
When using market-sensitive investments to supplement retirement income, a loss in value can rapidly accelerate the depletion of an account when compounded with withdrawals. As your account value drops, the percentage of your withdrawals increases.
Take an example of $1 million with a 4% annual withdrawal rate. The hope is that the account will earn more than the 4% to cover the withdrawal, but in a year when you may experience a loss of 20%, that 4% withdrawal is now a 5% withdrawal combined with the 20% market loss, equaling a 25% reduction in value. To recover the $250,000 lost and absorb the next year’s $40,000 withdrawal, the market must gain 38% to get back to the original $1 million.
Of course, it is possible to have a large gain following a year of significant losses, but you have to consider the possibility of a flat year or further losses. I won’t carry the math forward, but it is unlikely to be a happy ending.
When it comes to retirement income planning, consistency is the primary attribute, and having too much dependency on markets leaves you overexposed to sequence of return risk.
It is always easier to do nothing, especially when it comes to changing something that has been routine for years. We are creatures of habit and inherently avoid doing things that are uncomfortable, which can make retirement planning an uncomfortable process.
It can be uncomfortable because there is this propensity to want to keep everything the same while having your retirement needs met. Unfortunately, this just isn’t how this works. The need for income signals a metamorphosis from long-term growth to income now.
This is not intended to be an exhaustive list of potential mistakes but does highlight the most frequent issues I encounter when speaking with clients. Retirement is a balancing act between growing money for the future while drawing income for your retirement needs. There is no sure-fire way of accomplishing this, but there are best practices you can follow to help avoid the most common mistakes.
To learn how prepared you are for retirement, you can access a Retirement Checklist by visiting my website brianskrobonja.com.
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