This week I want to take a look back at a previous post and review the “SAO Formula”.
This particular topic was one of our very first blogs that we posted in the Fall of 2017. Hopefully, this gives you a good indication of how important we believe the SAO Formula is, how to use it, and how it can help you figure out how much you will need to retire.
What Is The Smart Asset Formula?
It is a guide from an outside, third party without a vested interest in selling you anything. The guide is trying to get an honest look at where you’re at financially, without trying to sell a product. With the SAO Formula, most people usually find out they are in a better position than they thought they were when they realize the return possibilities are better off of Wall Street.
We believe in gaining wealth through education and taking control of your finances; the Smart Asset Formula helps you do that.
The SAO formula takes into consideration several components to find your Freedom Point. Your Freedom Point is defined as the point where your transaction income meets your working income.
Here is how we measure that:
- Income Replacement
- How much income do you anticipate needing to maintain your current lifestyle?
- Current Passive Cash Flow
- Your investment income
- Available Capital Investment
- Do you have a business entity that you will be selling as part of your retirement plan? What about other anticipated capital from assets, windfall or inheritance?
- Return on Investment
- Safety and principal preservation must be high on the list of priorities; however, current conservative returns (CD’s, savings, US T Bills) are historically low today
- The Inflation Factor
- All fixed income investments are highly susceptible to inflation. The current federal government is stating the rate is around 2%, but is more likely to be 6% if calculated correctly.
- Taxes and Fees
- You must invest with the tax consequences in mind.
- Break Even Point
- Have you seen this equation? Undoubtedly no – because no one in the financial industry wants you to see this equation.
- Here is the formula:
- BER (break even return rate) = I (inflation rate) / (1-R) where R is the effective tax rate
Why We Avoid Investing in Wall Street
Before identifying your Freedom Point, you have to assess your current situation. Numbers can seem daunting, but don’t be deterred.
Say you ride the Wall Street roller coaster until your retirement. Hopefully when you decide to withdraw your money from Wall Street, you don’t get hit with huge capital gains taxes. With Wall Street, there is very little dependability and reliability. Your investments are at the whim of the market.
When the 2008 financial meltdown occurred, there were people working on Wall Street that didn’t even know it was happening. Not only is the market not reliable or dependable, but you also have no way of influencing it. It’s very risky. Having some sort of input or control is helpful.
Traditional financial advisors are not equipped with the knowledge to create plans that allow most investors to retire comfortably, and maintain their lifestyle. Usually, financial advisors tell their clients they need to be more cautious and conservative with their investments, which ultimately doesn’t allow investors to produce adequate returns for retirement.
For example, if you’re a doctor earning $250,000 per year and Wall Street averages around a 2% return, you will need $12.5 million to invest, in order to maintain your lifestyle and not attack your principal investment. Even at 4%, you’d need $6,250,000. For most people, that is out of reach.
Financial advisors on Wall Street often advise their clients to live on less than they did during their working years. What kind of insanity is that? Say you’ve been working for 40 years, you worked with financial advisors to manage your money and now the plan is to retire on less. Doesn’t sound like a great plan to me.
Let Your Retirement Be Your Retirement
What I can understand even less is when financial advisors tell their clients they have to cut back on spending, such as giving less to charity, in order to maintain the lifestyle they want. You work all your life, save and do all the “right” things, only to retire to a lifestyle below that of your working life?
When you retire, your free time opens up immensely. You’re going to want to travel, go out, do things you never had time for, give to the causes you care about, and pursue new opportunities.
In the Wall Street model, the basic strategy is, “Give us your money, trust us and we’ll invest it.” Essentially the mindset is that someone else is in charge of your money — not you.
The Freedom Point has a different philosophy by which you may be pleasantly surprised! The goal is to arrive at the point where your passive income surpasses that of your W-2 or transactional income.
If you can get your money out of Wall Street and on to “Main Street”, make the right connections and start to get involved in opportunities, you may be closer than you think. I can’t promise returns, but alternative investments, such as real estate, usually pan out pretty well if you can find the find opportunities and networks. Especially when you consider the benefits of taxation and inflation! Typically when you buy something in real estate, the property appreciates along with inflation — not the case on Wall Street.
Why The SAO Formula Will Give You Financial Freedom
The SAO formula incorporates something most people don’t think about when planning their retirement: traditional retirement plans are taxed and have fees. Many people are surprised by this because they don’t consider these or inflation costs.
Have you considered these factors when looking at the money you’re going to be taking out of your 401K or other traditional IRAs?
Once you understand your Freedom Point, ask your financial advisor if they can achieve the same returns needed just to break even, considering inflation and taxes. I would even ask them if they’ve seen the formula. Ask them what they believe your rate of return needs to be so you don’t spend your principle with consideration to taxes and inflation.
As we have said before, it is kind of grim to think about what you are losing when investing solely with Wall Street. But you can take some control back, take another look at the The SAO Formula.
When You’re Ready, We’re Here
We’d love to speak with you about starting your journey to financial freedom. You can contact us here for information about investment opportunities and ways to gain wealth education.