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We
are pleased to present the following
excerpt from the book
The Last Chance
Millionaire: It's Not Too Late to
Become Wealthy
by Douglas R. Andrew
Warner Business Books -
June 2007
The Myth
of Social Security as Your Primary
Retirement Income
When I ask people if they have any
guaranteed source of retirement, they
almost always answer, "Yes, Social
Security."
But is it smart to count on Social
Security as your primary source of
retirement income? Is it possible that
this national trust fund could be severely
depleted? Consider the facts:
- When Social Security was first
enacted during the Great Depression,
there were sixty workers to every one
recipient of benefits. Within just a
few years, that ratio was reduced to
fifteen to one.
- By the 1970s, it declined to six to
one. By the 1990s, there were three
workers in America for every one
recipient of benefits.
- Now, as the oldest Baby Boomers
prepare to begin retiring (or to
collect Social Security at 62, the
earliest allowable age), it is
estimated that before long there will
be two workers in America pulling the
Social Security wagon for every
rider.
- To keep it solvent, the Social
Security Administration has already
pushed back the age at which younger
persons will be allowed to collect full
benefits. If you were born between 1943
and 1954, you will not be eligible for
full benefits until you reach the age
of 66. If you were born in 1960 or
later, you will not be eligible for
full benefits until you reach age
67.
- With the upcoming workforce
decreasing and retirees living much
longer than when Social Security was
initiated, there will likely be even
more Social Security reform.
Because of these factors, the reality
is that Social Security benefits will
likely be a small supplement to your
retirement, not your primary source of
income. Even the Social Security
Administration says so.
The
Pitcher of Water Versus the Empty
Glass
When I give seminars, this is the
moment that I introduce the most memorable
visual aids I have ever used. Picture
yourself holding an empty drinking glass
in one hand and a pitcher containing water
in the other. The glass represents your
house. For simplicity's sake, let's say it
is worth $100,000. It's an asset. Let's
say you have $100,000 of cash in the bank
(the pitcher) -- that's liquid wealth. The
glass is empty because you have not put a
penny into your house, but on paper, on a
balance sheet, you would still list it as
a $100,000 asset. Meanwhile the pitcher of
water represents another asset -- $100,000
in cash.
What's the total amount of your assets?
$200,000. What happens if you pour the
water into the glass? You have reduced
your assets by $100,000. You've combined
$100,000 in cash to a glass already listed
as an asset worth $100,000, and all you
have to show for it is $100,000. You have
cut your assets in half!
On the other hand, when you separate
the liquid cash from the glass-sized house
that is free and clear, you double your
assets. That's what happens when you
separate equity from your house and put it
in a liquid investment. But you're not
finished. Assume the empty glass-house
appreciates at an average of 5 percent a
year. After one year, what's the value of
the empty glass? $105,000. If you pay off
the mortgage on the glass (pour the water
-- or money -- back into the house) what
is it worth? The same $105,000 -- whether
it is mortgaged or it is free and clear --
because equity has no rate of return when
it is trapped in a house.
Next, pour the water from the glass
back into the big pitcher. You've just
removed $100,000 from your house and put
it into an investment earning -- let's say
-- 10 percent. At the end of the year, how
much money will you have in that pitcher?
Look at that! It's grown to $110,000! In
your other hand is your house, worth
$105,000 at the end of the same year,
thanks to appreciation.
Leave the water in the pitcher.
How much have you earned by separating
your equity from your house in the course
of just a single year? $15,000. How much
would you have earned if you had left the
water in the glass? Only $5,000 --
one-third as much.
"But, but, but -- the mortgage wasn't
free! I had to pay some interest." That's
right, you did. Let's say the mortgage was
at 7.5 percent. That's $7,500 subtracted
from $15,000 for a net gain of $7,500,
instead of just $5,000. You are still 50
percent ahead than if you had not removed
the equity from your house. If the
mortgage interest is deductible, then the
net cost of the mortgage is really not
$7,500, but $5,000 in a 33.3 percent
marginal tax bracket. So the net profit is
$10,000 ($15,000 minus a net, after-tax
mortgage expense of $5,000) -- or twice as
much as you made if the house was paid
off!
Here's another quick analogy: Would you
rather have one horse working for you or
two? Can two horses work for you, even if
you owe money on one of the horses?
The object of this demonstration is
that no matter what else you do, when
you separate your equity from your house,
you increase your assets. Even though
there is a charge for doing that -- the
simple interest you pay on a mortgage --
it makes a whole lot of sense to take out
a mortgage and use it to make your assets
grow.
Do you recall the president of the bank
I mentioned at the start of this chapter?
What you've just done -- taken out a
mortgage and used the money to make more
money -- is what he did. You didn't make
billions, but you made a profit in the
same exact manner. By separating equity
from your house, you give it the ability
to earn a rate of return. Employ this
strategy each year, and the profits will
compound.
Copyright
2007 by Douglas R. Andrew. Published with
permission.
Douglas
R. Andrew is the owner and president of
Paramount Financial Services, Inc., a
comprehensive personal and business
financial planning firm. His previous two
books, Missed Fortune and Missed
Fortune 101, are national
bestsellers.
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