• Differences Between Roth and Traditional 401(k)

    The key differences between a Roth 401k and a traditional 401k account:

    Contributions to a traditional 401k account aren’t subject to federal and state income taxes for the year during which you make the contributions. When you withdraw your accumulated contributions plus investment earnings in retirement, you’ll pay ordinary income taxes at the federal and state income tax rates applicable to you at that time.

    It’s the other way around with a Roth 401k account. Contributions are subject to federal and state income taxes in the year you make the contributions. Withdrawals of accumulated contributions and investment earnings at retirement aren’t subject to income taxes.

    Traditional 401k accounts are subject to a required minimum distributions (RMD) when you reach age 70-1/2. At that time, you need to withdraw the minimum amount each year, and the amount you withdraw is included in your taxable income. Roth 401k accounts aren’t subject to the RMD.

    With a traditional IRA, you pay the taxes on the back end – that is, when you withdraw the money in retirement. But, in some cases, you may escape taxes on the front end – when you put the money into the account.

    With a Roth IRA, it’s the exact opposite. You pay the taxes on the front end, but there are no taxes on the back end.

    With a Roth IRA, you can leave the money in for as long as you want, letting it grow and grow as you get older and older. With a traditional IRA, by contrast, you must start withdrawing the money by the time you reach age 70½.

    Traditional 401(k)

    Contributions are made on a pre-tax basis: an employer takes money out of a pay check and transfers it in the employee retirement plan before withholding taxes. When the employee begins to take distributions, he/she will pay normal income tax on those distributions, and the income tax will be based on the employee’s tax bracket at the time of the distribution.

    Roth 401(k)

    Contributions are made after an employer withholds taxes. Because the employee already paid taxes, he/she will not owe taxes on distributions. (However, if an employee receives a company match on a Roth contribution, the company match is a pre-tax contribution. The funds that result from company matches and the associated growth will be subject to regular income tax when distributions are drawn at retirement.) It is noteworthy to mention that employees never owe capital gains taxes on any kind of 401(k) investments.

    Here is a simple breakdown of the difference between a Roth 401(k) and a traditional 401(k):

    • Traditional 401(k) = income taxes on distributions
    • Roth 401(k) = income taxes on contributions

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    Stock Market – Tips for New Entrants

    Stock trading these days has become popular unlike few decades back when it was only used by the rich. People want to make returns from their money besides their salary or profits from their business. Even with the popularity, many do not understand the basics and how to go about trading.

    Below are few tips for beginners.

    1. Invest available money: Always use the money that you have in spare or that has been kept aside for investment. Think of how losing this money can affect you before you invest.
    2. Educate yourself: If you plan to trade by yourself even if it is through an agency, it is very important that you understand the basics of the stock market. You need to also develop the habit of reading the everyday news as it majorly influences the market swing.
    3. Build a Portfolio: Your portfolio must have your investment plan, savings details, risk margins and your investment goals. If you choose stock market as your investment mode, then you will have to revisit your risk margin as compared to other investment plans it is more volatile.
    4. Setting up an account: It is very easy to set up a trading account. You can choose any one of the numerous stock broking agencies and start a trading account with them.
    5. Reduce frequent transactions: Beginners tend to buy and sell stocks a lot increasing the number of transactions per day. This could be to earn short profits or they listen to other sources of information on stocks like the news channel. Only your stock broking agency will gain from this as they charge you for each transaction and this may null all the profits that you had made from the transactions.
    6. Keep away from stock market scams: Keeping your money safe from scammers is also important. Promises of 50% return and higher profits are usually the tagline that people use to cheat investors.
    7. Protect your money using Limit Order: Even after analyzing the stock, its movement is still unpredictable due to the market fluctuations. Using Limit order will help buy stocks at lowest (while buying) and sell stocks at highest (while selling). Using Limit Order to buy .5 to 1% below the current price and .5 to 1% above current price for selling will save your money and provide profits.
    8. Spilt your money: Do not invest all your money in one company. Spilt it across various companies and sectors. Even if one fails, gains from the others will overhaul failure from one.
    9. Increase your investment and save profits: Unless you are looking for small monthly returns, invest your profits for greater returns. You can do this once you are confident of your judgments and have made some significant money. It is also necessary that you move your profits to your bank account
    10. Set up Dividend Reinvestment Programs (DRIPs): DRIPs invest the company dividends into buying additional shares. Over a period of time, you will own a significant amount of shares of the company.

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    Saving for Nest Egg

    The habit of saving little by little is the right thing for building a nest egg for future. This one is definitely for you if you are in your thirties and forties. It is about life after retirement where many dream of a retirement lifestyle. A Nest Egg is generally a substantial amount of money that has been saved or invested for a specific purpose for a long-term objectives, the most common being retirement.

    The term “Nest Egg” is derived from poultry famer’s where both real and fake eggs are placed in hens’ nests to induce them to lay more eggs. This meant more income for farmers.

    Breaking Down ‘Nest Egg’

    As nest egg represents funds that have been accumulated over a considerable time, preserving capital is the foremost investment objective of a best egg. Relatively conservative instruments such as certificates of deposit, bonds and dividend – paying blue chip are the investments for nest egg. The allocation of these securities should be based on investor’s risk tolerance and comfort level.

    7 Rules for Building Nest Egg

    1. Save 10% of your income for retirement

    A good way to build Nest Egg is when one has a regular job, then 12% of your basic salary and an equal contribution flows in your Provident Fund account regularly. Assume a 25 year old investor puts away every month a fixed amount, his savings will account for 44% of the total corpus when he is 60 years.

    1. 2. Increase investment as your income grows

    Suppose a 30 year old with a monthly salary of 50,000 starts saving 10% every month, he would have accumulated 92 lakhs by the time he is 60 years. An increase in the salary by 10% every year and a raise in his investment accordingly would get him 2.76 crore. The 10% saving rate is important to maintain so that your nest egg doesn’t fall short of your requirement.

    3. Don’t dip into corpus before you retire 

     

    Your Nest egg is at risk every time you change jobs as there is an option to withdraw your PF balance or transfer it to the account with the new employer. Thus filling a ‘Form 13’ transfers all the funds to your new account.

    1. Withdraw 5% a year initially, then step up

    One of the biggest challenges is to ensure that one does not outlive their savings. To ensure that you don’t face such a challenge, one must have a drawdown plan. Not more than 5% should be withdrawn in the first 5 years which can be progressively increased to 10$ by the time the retiree is 70.

     

    1. 100 — age = your allocation to stocks
      The performance of investment portfolio is determined more by the asset allocation than the returns from individual investments or market timing. An equity exposure of 100 minus your age is what experts recommend.

     

    1. Borrow for education, save for retirement

    Income tax deduction is available only if education loan has been taken under the Section 80E where the loan should be from a bank or notified financial institution. Financial discipline is inculcated in the child in case of an education loan.

    1. Save 20 times your annual expenses

    This rule is different from others because it is based on how much one spend on expenses like clothing and entertainment, not on how much investment earn.A smart tip is to get a health insurance cover that continues till you are 70-75 years old

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    Investing in Real Estate – Is it Safe?

    Investing in Real Estate – Is it Safe?

    Investing in real estate is held as part of a larger portfolio and is not for the faint of heart. Many variables are involved that makes investing in real estate profitable and that the same time these same variables may cost investor gar more than what they bargained for. A key in real estate investment is to identify a good property and if invested properly it can provide maximum returns with minimum risk. But a bad investment can really eat away money too, thus the investor needs to be aware of both the advantages and disadvantages of real estate investment.

    Benefits

    Some of the benefits in investing in real estate are as follows:

    1. Diversification Value: Real estate has a negative correlation with assets like stock, gold but the benefit it provides is diversification of asset. In case of stock market doing bad or a situation of economic boom, real estate would yield good returns.
    2. Yield Enhancement – Real estate allows one to achieve higher returns at decreasing risk
    3. Inflation Hedge – The returns from real estate are directly linked to the rents that are received from tenants. In inflationary environments real estate income tends to increase faster allowing an investor to maintain its real returns.
    4. Ability to influence Performance – An investor can do things to a property to increase its value or performance which include replacing a leaky roof, improving the exterior and restricting the building with higher quality tenants.
    5. Saves Income Tax – Tax benefits can be claimed if investment in real estate is made through home loan. Tax deduction U/S 80C (principal component-Max 1.0 lakhs) is applicable for first house which is self occupied whereas for second house benefit U/S 80C is not available. But complete interest component is eligible for tax deduction. For eg if a profit of Rs 30 lakhs is got from selling a property of 50 lakhs and if the profit is invested in another residential property within 2 years then the profit money will not be taxable.
    6. Provides Leverage : Use of leverage has mixed reactions.

    Case 1

    Suppose you bought a house worth 50 lakhs where Rs 10 lakhs was paid from your pocked(20%) whereas 40% through home loan (EMI Rs 40k per month).In one year the property value appreciates to Rs 55 lakhs. What will be the profit? 5,00,000 – 40,000×12 (EMI) + 60,000 (Principal paid) = Rs 80,000 (profit).

    Case 2

     

     

    Suppose you decide to buy within your means a property for 10 lakhs and within a year it appreciates to 11 lakhs. What will be your profit? Profit will be approximately Rs 1,00,000 – 10,000×12 (EMI) + 15,000 (Principal paid) = – Rs 5,000 (loss).

    The benefit of using leverage is that expensive property appreciates faster.

    .
    Some of the characteristics to be considered when making an investment decision are it is more efficient to purchase large real estate assets because one can spread the transaction costs over a larger asset base.

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    Fixed Index Annuity

    Fixed index annuities provide the guarantees of fixed annuities, combined with the opportunity to earn interest based on changes in an external market index. You are not actually participating in the market, but the money in your annuity (your “principal”) is not at risk.

    Fixed index annuity may be a good choice if you want the opportunity for accumulation, but don’t want to risk losing money in the market.

    Fixed index annuities can offer

    • Principal protection.
    • Tax-deferred growth.
    • One or more index allocation options.
    • A choice of crediting methods.
    • Income options, including income for life.
    • Death benefit options.
    • Optional benefits that may help protect your retirement assets and income (available at an additional cost)

    How do fixed index annuities work?

    The fixed annuities work beginning by you giving the insurance company money in one or more payments.

    • The insurance company then invests it on behalf of all annuity owners.
    • During the accumulation phase, your annuity will earn a fixed rate of interest that is guaranteed by the insurance company.
    • You defer paying taxes on your contract’s interest until you receive money from the contract.
    • Tax-deferred interest means the money in your contract can grow faster.
    • After a period of time specified by your contract, you may receive the amount allowed by your contract in a lump sum, over a set period of time, or as income for the rest of your life. This is known as the distribution phase.

     

    There are two types of fixed annuities: traditional fixed and indexed annuities.

     

    Traditional fixed annuities

    Traditional fixed annuities pay interest on the premium contributed at a rate declared by the insurer in advance. Some traditional fixed annuities offer multiple years guaranteed at the same rate, while others will leave the insurance company with the ability to adjust the rate annually.

    This rate can never be less than the minimum guaranteed rate stated in the policy.

    Indexed annuities

    Indexed annuities on the other hand are a type of fixed annuity which are regulated and distributed in the same manner as fixed annuities (through licensed insurance agents). However Indexed annuities provide a purchaser with various options for interest crediting.

    A buyer does have an option to elect a declared interest rate, and thus has a choice.

    An annuity should be used to fund a qualified plan based upon the annuity’s features other than tax deferral. All annuity features, risks, limitations, and costs should be considered prior to purchasing an annuity within a tax-qualified retirement plan.

    Bonus annuities may include

    • Annuitization requirements
    • Longer annuitization or surrender charge periods
    • Higher surrender charges
    • Lower interest rates
    • Lower caps
    • Higher spreads, or other restrictions not included in annuities that don’t have a premium bonus feature.

    It totally depends on you to choose the type of annuity you would want, however it is always advisable t make sure that you opt for a plan that would give you good and sure returns.

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    Fixed-Income Investments

    Fixed income investments, commonly known as bonds and money market securities, come in a variety of forms. They are simply loans made by an investor to a corporate or government borrower. For example, the borrower has to pay interest at a fixed rate once a year, and to repay the principal amount on maturity.

    Advantages of Fixed-Income Investing

     

    Fixed-income investments may be right for you if you want to experience these benefits as part of a diversified portfolio.

     

    • Preserve wealth – While fixed-income prices may fluctuate, you can rely on receiving the full-face amount when your investment matures.

     

    • Diversify your portfolio – Diversifying your investments across asset classes may result in less risk exposure for your overall portfolio.

     

    • Generate income – Fixed-income investments may provide a steady stream of monthly or quarterly income to help supplement your income or help fund your retirement.

     

    • Manage interest rate risk – By creating a ladder through staggered maturities, you can manage interest rate risk in both rising and falling environments and experience less exposure to interest rate volatility.

    The terminology used in connection with these fixed income investments is:

    • The issuer is the entity (company or government) who borrows the money by issuing the bond, and is due to pay interest and repay capital in due course.
    • The principal of a bond – also known as maturity value, face value, par value – is the amount that the issuer borrows which must be repaid to the lender.[2]
    • The coupon (of a bond) is the annual interest that the issuer must pay, expressed as a percentage of the principal.
    • The maturity is the end of the bond, the date that the issuer must return the principal.
    • The issue is another term for the bond itself.
    • The indenture, in some cases, is the contract that states all of the terms of the bond.

    Derivatives

    Fixed income derivatives include interest rate derivatives and credit derivatives are:

    Investors:

    • Investors in fixed-income securities are typically looking for a constant and secure return on their investment.
    • For example, a retired person might like to receive a regular dependable payment to live on like gratuity, but not consume principal.
    • This person can buy a bond with their money, and use the coupon payment (the interest) as that regular dependable payment.
    • When the bond matures or is refinanced, the person will have their money returned to them.
    • The major investors in fixed-income securities are institutional investors, such as pension plans, mutual funds, insurance companies and others.

    Fixed income securities have risks that may include but are not limited to the following, many of which are synonymous, mutually exclusive, or related:

    Before you invest, make sure you understand all of the risks and rewards involved.

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    Financial Instruments That Are Proven To Give Good Results

    Financial instruments are tradable capitals each having its own exclusive structures. If you are a new investor, you have to first know the types of financial instruments available. Below are few short term financial instruments that provide good returns. Few like Savings accounts, fixed deposits are 100% safe as far as the capital is concerned. The others are dependent on the market fluctuation and the company performance.

    Bonds

    A Bond is a Certificate of Debt delivered by a company or the government for the money you invest. The Bond promises the return of the invested money along with the fixed interest for a specific number of years. The duration can range anywhere between few months to 30 years. These Bonds can be traded and are safer when compared with stocks. When a company goes bankrupt, the bond holders are paid off before the stockholders.

    Savings Account

    Savings account is the safest and best way to invest your money. Withdrawal is easy and the money is mostly insured. Along with safety, this instrument provides a fixed interest amount.

    Stocks

    Based on the amount of stocks of a company you hold, you become part owner of the company’s assets. When the company performs well, you will receive dividends from time to time and you can also sell these shares at a price higher than you originally purchased making yourself a good amount of profit. However, when the company does not perform well, the stock price goes down and you may face losing your invested money.

    Mutual Funds

    Mutual Funds are pooled funds received from several investors with the same investment goal and managed by a professional institution. The fund managers makes the decision to invest this pooled money in stocks, bonds and other money market instruments. Usually, the fund manager splits your money and invests in various financial instruments to reduce the risk. It provides good returns for your investment however, the market risks are still unavoidable. You will have to pay certain amount of fee and the profits are taxable.

    Money market deposit accounts

    These deposit accounts provide higher interest rates than the Savings Accounts. They are however safe and you can easily access your money. There is a limit to the number of times you can withdraw money during the investment period.

    Certificates of Deposits (CDs)

    CDs are similar to Savings Accounts but offer higher interest rates. A CD is provided for the amount of money you invest. The interest rates vary based on the number of years you invest. Usually, longer the investment period higher the interest rate. Premature withdrawals attract penalties.

    Fixed Deposits

    Fixed Deposits (FDs) are lump sum amounts invested with the bank. They are safe and provide very good interest rates. The profit is however taxable. It is a safe way of investing money and is suitable for people who have long term investment plans.

    There are also other financial instruments like National Pension System, Savings Certificates, Provident Funds, and Insurances and so on. that are suitable for individuals looking to make long term investments. These are best suitable for people who are looking to have a retirement cushion, pay for children’s education or want to buy a house.

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    Best 529 Funds

    529 funds are quite common in the western world where one can save for future education costs. These are mostly funds which are sponsored by states or educational institutions and have tax benefits. They are technically called ‘qualified tuition plans’. Parents or grandparents who wish to do something for their grandchildren can utilize the benefits of these plans to secure the future of their kin.

    Available Choices

    Before investing in these funds one must know the options that are available to them. There are basically two types of funds. One is age bases while the other is static. In age based option, the fund will be inclined to growth of the investment and hence stocks will be the primary option under investment. As the person grows and reaches college going age, the fund will be inclined towards conserving capital and investments will primarily be made in bonds and cash. Under the static option the choice of investment in stocks or bonds rests with the plan owner and unless there is an instruction from him, the investment will continue as per the initial request.

    Best 529 Funds

    1. College America – Virginia

    College America is a 529 student savings plan which is offered by Virginia529 which is an independent agency of the common wealth of Virginia and American Funds. This fund has tax benefits and unlike other 529 plans lets the owner of the plan invest in one or more American funds. This fund has to be managed only by a financial advisor namely ‘Capital Research and Management Company’ which is one of the reputed and oldest investment management firms in USA.

    1. The Vanguard 529 College Savings Plan – Nevada

    Vanguard College Savings Plan is one of the low cost providers in the industry which usually end up in more savings. They offer three age based options and have 19 investment portfolios that one can choose from. In order to manage the accounts, they engage top investment professionals. It is easy to invest in these funds as they can be linked to your bank account. They also ensure that personal attention is given to each account and have a highly satisfactory customer service.

    1. Utah Educational Savings Plan

    Sponsored by the state of Utah, this is the only plan that is sold directly, in the sense that one can start an account and invest directly. This works well even for a non resident of Utah. Being a nonprofit trust fund, the investments made are subject to market performance and risks underlying with it. There are no guarantees on the returns; however they have FDIC insured investment options.

    1. College Advantage 529 Savings Plan – Ohio

    Under this fund, they have 2 age based options and 6 portfolios. The best part of this investment is that you can either choose to manage by yourself or can employ a financial advisor. If one chooses to invest and manage by himself then there is no maintenance cost or enrollment fee, plenty of investment options and comes with tax benefits.

    The above mentioned funds are some of the best in the industry. However, none of them come with any guarantee that the saved fund will be sufficient for college tuition fee. All of these funds are subject to market risks and performances. Hence it is best to choose and invest in the right fund with the right amount of money.

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    Best 401K Investments

    The Best 401K investments are those supported by the employers who make a matching contribution and make investments to help us retire with dignity.

    The Best 401K investments are selected are usually based on the fact that 1. Employees were immediately vested in the plan 2. Employers matched the employees by contributing 6 to 9% in basic and also towards additional contribution.

    The Best 401K plan is also selected based on the fund offering and expenses. If the charge is more than 0.8% annually, then it is not worth it.

    The trends in 401K plans are Employer Matching Stretching, Re-Enroll and employees paying more fees.

    The top 10 401K Plans as per BrightScope in 2014 are:

    1. NFL Player Second Career Savings Plan
    2. Southwest Airlines Pilots Retirement Savings Plan
    3. The Savings Plan of Saudi Arabian Oil Company
    4. Wellington Retirement and Pension Plan
    5. Employee Savings & Stock Ownership Plan Of General Re Corp
    6. Amgen Retirement and Savings Plan
    7. UPS/IPA Defined Contribution Money Purchase Pension Plan
    8. ConocoPhillips Savings Plan
    9. Bayer Corporation Savings and Retirement Plan
    10. ExxonMobil Savings Plan

    If the choices of the 401k investments are many, then the following types of investments can be considered:

    1. Target date funds

    It is an age based fund. It is a lifelong management investment strategy. The main benefit of this fund is that it helps the investor to keep track of the investment. The problem with this fund is that the fees might run high, thus, making the performance decrease overtime.

    The Best in this fund sector is

    1. Fidelity
    1. Mutual Funds

     

    In theory, a mutual fund selection offers variety of choices. But in reality, it is not so. Mutual funds have greater chances of getting better or worse after some point of time. The advantage of mutual fund depends on the retirement investor who tunes the portfolios for you.

     

    The Best 401k Mutual funds are:

    1. Fidelity Contrafund
    2. Fidelity Low-Priced Stock
    3. Rowe Price Mid-Cap Growth
    4. Rowe Price New Horizons
    5. Vanguard 500 Index Fund

     

    1. Index Funds

     

    Index funds are investment schemes aims to replicate the movements of index i.e., the investor has a choice to invest in a large number of companies without buying individual stocks. It’s a collection.

    The best Index funds are:

    1. Vanguard Total Stock Market Index
    2. Vanguard Small-Cap Value Index
    3. Vanguard FTSE All-World ex-U.S. Index
    4. Vanguard Emerging Markets Stock Index
    5. Vanguard Intermediate-Term Corporate Bond Index

    The best investment plans always depends on the individual. If the plan is limited, it is easy. But if the choice is broad enough, it needs a lot of constant thinking and observation.

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    Why 401(k) Is Considered The Riskiest Investment

    The 401(k) is often considered the no-brainer, gold standard of retirement plans. The supposedly dependable 401(k) is not your best choice for retirement. Here are some dangers of a 401(k) for you to consider.

    You can be wiped out overnight.

    • Your 401(k) rises and falls with the stock market where you have absolutely no control.
    • Retirement planners will tell you the market averages 8-11 percent.
    • But From 2000 to 2015, the market was up just 8.4 percent total when adjusted for inflation, or 0.56 percent per year, and that was after a substantial market rally.

    Administrative Fees And The Tyranny Of Compounding Costs

    • The toll taken by 401(k) and associated mutual fund fees is staggering, and can eat up more than half your gains.
    • With 401(k) s, there are usually more than a dozen undisclosed fees: legal fees, trustee fees, transaction fees, stewardship fees, bookkeeping fees, finder fees and more.
    • If a fund is up 7 percent for the year, they take 2 percent and you get 5 percent. At first it sounds like you are getting more, yes, but in the end the mutual fund wins.

    There’s No Cash Flow For Better Opportunities

    • Money left to compound unpredictably for 30 years is stagnant money. There’s no cash flow ready to direct to today’s best uses.
    • Instead, it’s sitting still inside one 30-year bet, while newer, better opportunities may be passing you by.

    Lack of Liquidity When You Need It Most

    • Money in a 401(k) is tied up with penalties for early withdrawal. This means you can’t spend or invest your money to enrich your life without great difficulty and/or taking a big financial hit.
    • The only exception allows you to borrow a limited amount of money from your 401(k) if you promise to pay it back.
    • This automatically leads to double taxation, the worst being if you lose your job or your income dries up, the deal changes and you must repay the loan within 60 days.

    Lack of Knowledge Encourages Unconscious Investing

    • Do you know the funds in which you have invested? Do you know the details of the companies inside those funds? Do you know the fund manager’s philosophy, history, and performance? How can you expect to gain a return from something that you know so little about? And how can this be called investing? It’s not investing, it’s gambling.

    Fear of Taxes Leads To Underutilization

    • 401(k)s are tax-deferred, meaning you avoid paying taxes today by committing to paying them later.
    • The tax deferral aspect of the 401(k), which is a great boon, is actually a primary factor contributing to its underutilization.
    • Finally, the retirees to let the money sit for fear of triggering burdensome tax consequences.

    Higher Tax Brackets Upon Withdrawal

    • People will have healthy returns on their qualified plan while at the same time figuring they’ll be in a lower tax bracket at retirement.
    • If you have achieved any success, you should actually be in a higher tax bracket at retirement.
    • However, assume the opposite. Even worse, those higher tax brackets are likely to be even higher in the future.

    No Exit Strategy

    • Early withdrawal penalties, over-the-top borrowing rules, daunting taxes, these are all incentives never to touch the money, ever.

    Lost Without a Comprehensive Plan

    • Many people whose finances are in shambles, yet who continue to contribute diligently to their 401(k) plans.
    • You need a macroeconomic, big-picture plan that identifies, prioritizes and manages all pieces of your financial puzzle in harmony with each other.
    • You don’t need a general, one-size-fits-all plan that’s sold to everyone.

    Neglect of Stewardship and Responsibility

    • In short, saving for retirement is wise and prudent. But other investment philosophies, products and strategies can meet your financial objectives much more quickly and safely than a 401(k).
    • Investing for cash flow, or investing directly in a business, or Cash Flow Banking, where you become your own “bank,” could be smarter moves.
    • Even paying off a high interest rate loan can be a smarter move than contributing to your 401(k).

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