Bad investment advice

I was doing some reading this morning and was thinking about defined benefit vs. defined contribution plans and trying to find some actual numbers from a source which would know what they were talking about to show some real numbers behind which decision people should make.

The article I turned to first was from Forbes, which is in my view is a fairly reliable magazine for financial issues. The first yellow flag was a lack of charts plotting how fast someone’s investment would grow, and not showing their work regarding inflation. As I read through I found a glaring error.

The article assumed that someone would only deposit 8% of their income from a match from the employer. But employer matching contributions only occur if you have already contributed that much from your salary. It is usually a dollar for dollar match to your contribution for your retirement.

Now, if you were only contributing 4% of your salary (accounting for inflation of course) then the numbers in the article were correct, and you would only end up with $22,000 of retirement income in 25 years (the short time frame this article was based on) which is clearly not enough. This is not what the article stated however, and only depositing 4% of your income in retirement is a terrible decision.

The golden rule of thumb for savings is simple. You should save for retirement as early as you can, diversify across many industries, and invest as much as you can every year. Contributing only 4% of your salary to your retirement plan is utterly foolish, especially if you have paid down your debt and have a Home Equity Line of Credit on your home.

Once we readjust their assumption that you are only depositing 8% of your income in total in your retirement plan, and account for inflation, continuing their 5% after inflation investment rate (which is approximately the 8% market rate of the S&P 500 times 2% inflation), you will end up with $749,529 in today’s dollars, or $1.2 million without adjusting for inflation, which will provide you with $58,000 of income in today’s dollars. This is almost double what you would receive from the annuity they are using as a comparison. This is also only after working for 25 years.

The article was written to make it look like a hard decision, but in reality, every defined benefit plan I have ever looked at has come in far short of a defined contribution plan, even before accounting for accidents which can occur, ending your life, making defined benefit plans disappear, unlike defined contribution plans which are inheritable upon your death. I have yet to find a traditional pension plan which performs well in comparison.

No matter what age you pass away, the plan with a balance will always win, whether you die at 70 or 100.

Be careful about the media you read, it can really mislead you if you don’t read carefully. Even fairly well reputed magazines can sometimes make glaring errors.

YearSalaryDepositBalanceInflationReal valueInterest
1$80,000.00$12,800.00$12,800.001$12,800.00
2$82,400.00$13,184.00$27,008.000.98$26,467.84
3$84,872.00$13,579.52$42,748.160.9604$41,055.33
4$87,418.16$13,986.91$60,154.920.941192$56,617.33
5$90,040.70$14,406.51$79,373.820.92236816$73,211.89
6$92,741.93$14,838.71$100,562.440.9039207968$90,900.48
7$95,524.18$15,283.87$123,891.300.885842380864$109,748.17
8$98,389.91$15,742.39$149,544.990.86812553324672$129,823.83
9$101,341.61$16,214.66$177,723.250.850763022581785$151,200.37
10$104,381.85$16,701.10$208,642.210.83374776213015$173,954.97
11$107,513.31$17,202.13$242,535.710.817072806887547$198,169.34
12$110,738.71$17,718.19$279,656.760.800731350749796$223,929.94
13$114,060.87$18,249.74$320,279.040.7847167237348$251,328.32
14$117,482.70$18,797.23$364,698.600.769022389260104$280,461.39
15$121,007.18$19,361.15$413,235.630.753641941474902$311,431.71
16$124,637.39$19,941.98$466,236.470.738569102645404$344,347.85
17$128,376.52$20,540.24$524,075.630.723797720592496$379,324.75
18$132,227.81$21,156.45$587,158.130.709321766180646$416,484.04
19$136,194.64$21,791.14$655,921.920.695135330857033$455,954.50
20$140,280.48$22,444.88$730,840.550.681232624239892$497,872.43
21$144,488.90$23,118.22$812,426.020.667607971755094$542,382.09
22$148,823.57$23,811.77$901,231.870.654255812319992$589,636.19
23$153,288.27$24,526.12$997,856.550.641170696073592$639,796.38
24$157,886.92$25,261.91$1,102,946.980.628347282152121$693,033.74
25$162,623.53$26,019.76$1,217,202.500.615780336509078$749,529.37$58,763.10

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