Figure out your investment time horizon

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“Time is on my side, yes it is” –Rolling Stones, Time is on my Side

Okay, you’re ready to join me in the land of financial freedom.  One of the first things you need to figure out your time horizon for the money you’re saving.  Will you need that money in a couple months or sooner, in the next couple years, in the next ten years, or at retirement?  These answers will have the greatest impact on how you invest it.  Here is my take (and as always, I’m not an expert, and these are just my opinions; any predictions I make about the future are just based on historical trends, and you should establish your own opinion on the future).

 

Extremely short-term (tomorrow to next 6 months)

Your property tax bill, ‘Lil Fox’s preschool tuition payment, living expenses if you’re retired like Grandpa Fox.  With such a short time horizon, you really don’t have a lot of options.  For amounts less than $5,000, it’s probably easiest to keep it in your checking or savings account, even though the typical interest rates on those accounts are practically zero.  Money market accounts would offer a little more interest, but even then you’d be looking at 2% or less, so it may not be worth the $1.50 per month in interest you earn on $1000 to set something up.

If you’re talking a larger amount of money, you want something that has a very low risk of decreasing in value, but still offers an interest rate that makes the effort worthwhile.  Short-term bond funds like Vanguard Short-Term Bond Index (VBISX) may fit the bill.  There’s a pretty small chance that your investment will decrease in value (but it’s not 0% so be prepared), but you can still earn a decent ~3% interest; that’s about $25 every month for a $10,000 investment.

 

Short-term (6 months to 3 years)

Car fund because you have a 2001 Honda Civic with a bad transmission (the Fox family in June 2013), vacation you want to take to Hawaii without the kids two years from now.  Because you have extra time compared to the “extremely short-term”, it’s definitely worth it to invest for any amount more than $500.  Similar to above, you probably want a bond fund of some sort, but because of the extra time you can take on a slightly more volatile investment and grab the higher return.  Something like Vanguard Medium-Term Bond Index (VBIIX) gives a decent return, about 4% historically, with a pretty low risk that you’ll lose more than you gain over a year or two.  Just so you hear that “cha-ching” sound in your head, if you invested $1000 in a bond fund, after three years at 4% interest, you would have about $1125, a tidy little $125 profit earned for nothing more than being smart about where you put your money.  That could fund those Mia-Tias on the beach in Hawaii while you remember all the extra free time you had before the kids came along.

 

Medium-term (3 years to 10 years)

Mini Fox’s college fund, down payment on Mrs Fox’s dream vacation house down the shore.  With a longer time horizon, your options really start to open up.  A few years starts to give you the time to weather some moderate financial storms, but probably not enough to go fully into stocks (ask someone who invested money in October 1929 or November 2000).  The winner is probably some balanced fund like the Vanguard Balanced Index Fund (VBINX).  These balanced funds will have a mix of bonds, with the price stability they provide, and stocks, with the potential for higher returns those provide.  For those closer to the 10-year mark or those willing to take a little bit more risk for a higher return, you could jump into an all-equity mutual fund like Vanguard Total Stock Fund (VTSMX).

 

Long-term (10 years to retirement)

Mr Fox’s 401k, Mrs Fox’s IRA.  Once your time horizon gets past 10 years, things start to get interesting and fun.  Because this is where most of your savings for retirement should be (unless you’re Grandpa Fox, enjoying retirement), this is where I’ll focus most of my time.  Also, because this is where you have the most options, this is where there’s the biggest risk that you can screw it up and cost yourself tens or hundreds of thousands of dollars over the years.

While we can spend a ton of time discussing this (and believe me, I will) a simple starting point on where to put your money for something like this is the Vanguard Total Stock Fund (VTSMX).  In time, we’ll discuss other investment options but this is a good start.

 

In the cases of the medium-term and the long-term strategies, at this point you are truly entering the world of investing.  Welcome.  Your returns on any particular year can range from -10% or worse to 20% or better, and you can count on the fact that sometimes it will be a bumpy ride.

Inflation won’t be as bad as everyone thinks

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“Ocean waves will grind the greatest boulder into sand if given enough time”

Inflation, the general rise in prices over time, is a powerful and unrelenting force which is eroding the value of your money every year, every month, every day.  How powerful is inflation?  Look at this simple example with my neighbors, Mr and Mrs Grizzly.

If they want to spend $50,000 per year (in today’s dollars) in retirement they’ll need about $1.2 million on the day they retire (40 year retirement, 6% return, 3% inflation).  Every year in retirement they’ll spend a little more than $50,000 to buy what $50,000 buys today because of inflation.  However, if you crank the inflation knob up a notch from 3% to 4%, they’ll need $1.5 million.  Up to 5%, they’ll need $1.8 million.  What makes inflation so scary is that the impact is huge—a 2% increase requires your nest egg to be $600,000 larger—and it’s also completely out of your control.

In the US, inflation is tracked by the Bureau of Labor Statistics, a division of the Department of Labor, with a tool called the Consumer Price Index (CPI).  Basically (I know it’s much more complex, but for brevity’s sake) it looks at a general basket of goods that people buy and tracks how those prices change over time.  It’s meant to track EVERYTHING that consumers buy: food, housing, cars, airline tickets, medical expenses, entertainment, and on and on and on.  The US boasts an amazing record of tame inflation over the decades, but even then it’s been quite a roller coaster: in the early 1980s, according to the CPI, inflation was averaging about 12%, and it has averaged about 1.6% since 2009.

That just ruined Mr Grizzly’s day.  So he needs $1.2 million today to retire, but depending on inflation it could range from $1 million to $8 million if it got as high as it did in the early 1980s?!?!?!  No bueno.  How the heck is he supposed to plan for a range like that?

 

The unfortunate answer is: there really isn’t a good answer.  Inflation is going to do what it will do, and there isn’t a lot you can do about it as an investor.  The US government sets an inflation target at 2%, but reasonable people can debate how good Washington is at managing stuff like this.  When I do my planning for the Fox family, I personally use 3%.  But there is some good news—I actually think the CPI waaaaaaay over estimates inflation and that it is going to be on the lower side of historic averages, which is a good thing for those of us saving for retirement (as always, this is just my opinion and may turn out to be quite wrong, also with my projections I am not predicting the future).

The CPI is supposed to compare apples to apples, so basically what did you buy last year and how much would that cost if you bought the exact same stuff this year.  I think over the short-term the CPI works pretty well; I’d believe that prices in 2014 were about 2% higher than in 2013 (in line with the CPI’s figures).  But over longer periods of time, the CPI really fails because I think it does a really lousy job of dealing with major technological advances.  So when you look at 10 or 20 or 50 years, which happens to be the time horizon we’re looking at for retirement, I think the CPI really overestimates inflation.

If you go back to 1965 (I picked 50 years ago, because I figure I have 50 years to live, so that’s my time horizon), the CPI says prices have risen about 7.5 times.  So something that cost $100 in 1965 would cost about $750 today.  If you do the math, that equates to about 4.1% per year.  We saw the impact that the level of inflation has in the above examples (pretty major impact), yet let me tell you why I think the government is getting it wrong and there is some real relief.  This is going to be a long post (but I hope a valuable post), so get comfortable.

 

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Cars

In 1965 you could get a new 4-door sedan like the Chevy Impala for about $3000.  Today you could get a new 4-door sedan like the Honda Civic for about $20,000.  If you do the math, that calculates to about 3.9% inflation per year, right around what the CPI says (I know, you’re saying: “Stocky, so far I’m not impressed.”)  But remember, the CPI is supposed to compare apples to apples; when you compare a 1965 Impala to a 2015 Civic, the Civic has a ton of advantages.

The Civic gets 35 miles to the gallon, while the Impala got about 12.  The Civic has incredible safety features like airbags, antilock brakes, backup camera, and on and on; the Impala has seat belts across your lap (they didn’t even have the shoulder ones).  The Civic has Bluetooth to connect to your MP3 player, while AM/FM was an option on the Impala.  A new Civic will probably last you 200,000 miles or more, but your Impala would be lucky to get to 100,000 (like “go-out-and-buy-a-lottery-ticket” lucky).

Put all that together and how much of that 3.9% annual price increase is due to inflation, and how much is due to the Civic just being a better car?  It’s not an easy question to answer, but I would think an awful lot of the price increase is because you’re getting a safer, more fuel-efficient, and more durable car . . . just a better car.

To look at it from a different angle, we know $3000 in 1965 would buy you a new Chevy Impala.  What would $3000 buy you in 2015?  A quick look at Autotrader.com shows that for $3000 you could get a 1998 Honda Civic with 150,000 miles.  Between those two choices, each of which is $3000, don’t you have to pick the Civic as the better car?  It’s safer, much more fuel efficient, has more convenient features (cruise control, automatic windows), and it will probably last longer.  All that says that inflation was actually a lot less than the 4.1% the CPI said or the 3.9% we calculated.

 

Rent

Housing is the biggest expense that people have, so how does that come into play?  In 1965 the average rent was about $90 per month while in 2011 it was around $870 which calculates to about 5.1%.  That’s higher than the CPI, but before we freak out about runaway inflation in the housing market, let’s do the apples-to-apples comparison.  In 1965 you were getting a place where you might have shared a bathroom with your neighbor and a phone too.  You had an icebox instead of a fridge (literally a cabinet that you kept cool with blocks of ice), and radiator heating.

Today you have granite countertops and stainless steel appliances, central air conditioning, and a fitness center downstairs if you’re lucky.  How much of that 5.1% increase is due to prices rising, and how much is due to you just getting a much, much nicer place with much better amenities?  Today, I’m sure if you tried hard enough you could get a total armpit of an apartment that was completely vintage 1965, and I bet you probably wouldn’t pay more than a few hundred bucks for it, showing that prices for apples-to-apples apartments haven’t risen near that 5.1% level.

 

Heart Stents

Healthcare

Ahhhh.  This is where you’re saying: “But what about healthcare?  Medical prices are spiraling out of control.  That’s where they get you.”  The Medical CPI shows that prices have increased an astounding 17 times since 1965—about 5.9% annually.  Mr Grizzly just had a minor aneurysm, which he knows is really going to cost him.  But before you despair, do the apples-to-apples comparison and realize that the quality of healthcare has gone up exponentially while costs it can be argued have come down.

Let’s say Grandpa Fox had a heart attack in 1965.  First, his chances of survival weren’t very good, but let’s assume he survives and gets coronary bypass surgery.  After two months of recovery he’s back at home living his normal life, but now with a sweet scar running all the way down his chest from the open-heart surgery.  That surgery back then would cost around $6000 (it’s hard to find exact numbers on this so I estimated; any reader who has better data please let me know) which is a drop in the bucket compared to the $100,000 price tag bypass surgery costs today.

Unfortunately, Grandpa Fox passed his lousy heart genes on to me.  However, instead of a heart attack hitting me out of the blue, my doctor discovers early on that I have high cholesterol and prescribes me Lipitor which costs about $300 per year, and that is even lower if you go generic.  My heart problems get taken care of for much less money, plus I didn’t have to go through a high-risk surgery and brutal recovery.

But maybe Lipitor doesn’t work, so after a while they find my coronary arteries are severely blocked and I get a stent (of course, I only use a Medtronic brand stent).  I have a non-invasive surgery where they insert the stent through a tiny incision in my hip, I go home that evening, and it all costs me about $20,000.  Like before I probably would have a much better outcome than Grandpa Fox, at about three times the cost which equates to about 2.4% inflation over the 50 years.

So while medical expenses have skyrocketed (and I totally agree they are out of control), if you look at the idea of taking someone with a heart problem and getting them back to health, prices have actually gone way down since 1965.  So much for aggressive inflation here; you could actually argue that there has been deflation.

 

Food

So let’s compare apples to apples, literally.  Apples in 1965 cost about 16¢ per pound while today they are about $1 per pound (at least in LA)—that equates to inflation of about 3.6% inflation.  But there is actually a difference between 1965 apples and 2015 apples.  Back then there was this weird concept of fresh fruits and vegetables being “in season.”  You could only buy apples certain times of the year which was around late summer and fall (I had no idea so I actually had to look this up, which kind of proves my point).  Today fresh fruits and vegetables are in season when your grocery store is open and you have money.  So again, you’re paying more but you’re also getting a better product as well—year round fresh fruits and vegetables.

 

And there are many product categories whose prices have fallen drastically (air travel, anything with electronics), and others that we used to be charged for but are now free (telecommunications, news articles).  The whole point of all this is that depending on how you look at it, inflation isn’t going to be nearly as high as the CPI says which is a huge help to savers.  That means your dollar will stretch further in retirement than you might otherwise think, and that you’ll need less to retire on.  Consider this my gift to you.

Book review: The Millionaire Next Door

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“I drink two kinds of beer—free and Budweiser”—millionaire interviewed in book

The Millionaire Next Door definitely deserves a place near the top of any list of books on personal finance.  Its two authors, Thomas Stanley and William Danko, were two professors who undertook a massive study of America’s millionaires to figure out what made them tick.  How did they get rich? How did they stay rich?  And generally, what are their views on money?

Reading this is almost like watching an archaeological documentary on PBS with Will Lyman narrating: “Americanis Millionairo is a subspecies whose prodigious wealth-building abilities have been studied for centuries.”  Basically, the authors conducted thousands of interviews with millionaires and asked them questions on nearly every subject of personal finance, and the book is those survey results.  Nearly every aspect of millionaires is examined to find common themes—working income, country of origin, education, divorce status, occupation, Rolex-ownership, and a hundred others.

Distilled down to its simplest, the book reaches two conclusions which are really opposite sides of the same coin:

  • Frugal spending habits are the single biggest factor to being able to become a millionaire.
  • Flashy spending occurs among a small minority of millionaires, and in fact flashy spending tends to be a major factor to not becoming a millionaire.

For those aspiring to be millionaires it’s a wonderful how-to guide on becoming rich the slow-but-steady (and boring) way of spending less than you earn, making luxuries an special indulgence instead of a daily staple, and generally have a grounded view on life and expenditures.  It’s analysis shows that most millionaires get that way by prudent spending and diligent saving; not by having jobs that pay million dollar salaries, not by inheriting the money from rich relatives, and not by “hitting it big” in some venture.   It’s this element of the book that is most powerful—it democratizes millionairehood (I just made that word up).

For those who are already millionaires and became so by leading a life with “sensible spending”, I think it provides comfort that they aren’t alone.  Our society is bombarded with images of what “rich” people should look and act like.  In the 1980s shows like Lifestyles of the Rich and Famous (I must confess a favorite of mine as a kid) celebrated the over-the-top extravagance of the wealthy.  That tradition has continued with a myriad of shows like Platinum Weddings (a favorite of Foxy Lady) and Million Dollar Rooms to name just two.  However, the book does a tremendous job of breaking through those stereotypes to show that the vast majority of America’s wealthy are just normal people who spend their money sensibly or even frugally.

 

In true academic fashion (one of my criticisms of the book is that is reads more like a research paper than a bestseller, but it is a best seller, so what do I know?) the authors break down pretty much every demographic element of millionaires and just as interestingly, those people who make a bunch of money but aren’t millionaires.  Some of the findings are obvious like there are a lot of millionaires who started their own business.  But others are make a ton of sense but wouldn’t have been top of mind as such a determining factor; an example of that is divorce which the authors describe as a millionaire killer (Foxy Lady—have I told you how much I love you?).

They slice and dice things and thousand different ways.  What do you want to know about your average millionaire?  Average age of car (2-3 years), percentage self-made (80%), attended public schools (55%), ancestry (Russian followed by Scottish), percentage who have a JCPenney card (30%), and on and on.

 

Of course, I look at these things through an investing lens, and I was a bit disappointed that the authors spent so little time on this subject.  In a book with almost 300 pages, only about 4 or 5 are dedicated to what millionaires do when investing their money.  And this seems like a major gap considering that investing can be as responsible for building wealth as earning the money in the first place.  They cover the most the millionaires have paid for a suit, a watch, a pair of shoes; but they don’t talk about what type of investments they make?  Seems weird.

The three major takeaways about investing you get from the book are:

  • About 80% of millionaires do invest in stocks and other securities. This seems obvious, and actually a little low.  What are the other 20% doing.
  • Most use a “buy-and-hold” investing strategy as opposed to actively and frequently trading stocks. I’m glad to see this (this is a topic for another blog post).
  • Considerable time is spent discussing how millionaires go about hiring a financial advisor.

If I had my way I would have loved the authors to really dive in here.  If you believe that the point of the authors writing this book is to show the masses how they can become millionaires (and I believe that to be true), then after they adopt the “frugal” spending habits, then it becomes important to know what to do with the money after they’ve saved it.  Here is my list of a few questions I would have loved to know:  What percentage use a financial advisor versus do it themselves?  Do they tend to invest in individual stocks or mutual funds?  How much of their portfolio is in stocks versus bonds?

 

Overall, the book reads a little stiff, and at some times it gets preachy (especially the section on how to discuss money matters with your kids) so that’s a bit of a turn off.  Also, it was written in 1999 and because of that there are a lot of areas that are quite dated and don’t really apply to the world 2015.  But it does provide tremendous insights into their everyday activities of these people and how those have help them accumulate so much wealth.  For all that it gets 2 ½ stocky foxes.

2.5 foxes

 

As a closing note, I want to thank my coworker who gave me this book as a Christmas gift back in 1999.  You know how you are, and I hope you know how much I enjoyed reading this.

Week in review (6-Mar-2015)

Weekly review (2015-03-06)

 

The week was dominated by moves (or anticipated moves) by central banks.  We had a pretty flat week until the bottom fell out for everyone.  Pacific stocks did the best (Thank you China) being down only 0.7% while the US and Emerging stocks were down about 2%.  That leaves the European stocks which really got hit hard, down almost 3%.  Wow!!!  So what caused it all?

 

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NASDAQ hits 5000 for first time since 2000:

On Monday Wall Street celebrated a bit of a milestone when the NASDAQ returned to above 5000 for the first time since the internet bubble popped 15 years ago.  It wasn’t a story to drive the market, as much as it was a story about how the market has been driven by amazing companies like Apple, Whole Foods, Amazon, eBay, Amgen, Cisco, and others.  Of course that didn’t stop all the news outlets from devoting considerable time to remembering 15 years ago.  My favorite part was looking at the CNBC footage from then and the hairstyles in vogue at the time.  You never realize how much those things change, even in a few years, but man do they ever.

Interestingly, the milestone did prompt a lot of soul-searching  as to whether or not we were in a bubble now, the way we were back then.  15 years ago, a lot of people got taken up in the euphoria of the skyrocketing stock market, only to get crushed when the party ended.  It’s natural to want to look at that now to avoid those painful experiences, but as we learned in A Random Walk Down Wall Street, crashes are really hard to predict.  Overall, this was a nice trip down memory lane, but nothing that really had meaningful implications for the markets.

 

Both China (Monday) and Europe (Thursday) ease monetary policy:

Janet Yellen isn’t the only central banker that can monkey with interest rates to drive markets.  The week started on Monday with China lowering its key interest rate.  As you would expect, this had a very positive effect on Pacific and Emerging markets.  However, this is always a bittersweet move, and one that may have some major implications in the future.  China is lowering its interest rate to spur economic activity because it thinks its economy is slowing.  In the past several years, China has been a manufacturing juggernaut, so to think that the second biggest economy in the world may be slowing down is not a positive for stock markets.

In a similar story in a different part of the world, the European Central Bank announced that it would mimic the US’s quantitative easing program by buying over €1 trillion (trillion with a “t”) in bonds.  Broadly speaking, the European economy is a mess right now.  At best you have the stronger economies experiencing slower growth, and at worst you have Greece in shambles and other countries like Italy and Spain thinking about following Greece’s “budgets be damned” path.  Certainly quantitative easing seems to have worked for the US (but the jury is still out as to its long-term effects), but Europe is in a very different place economically and politically compared to the US.  You kinda get the sense that the ECB is just throwing a bunch of “stuff” against the wall and see what sticks.  Not surprisingly European markets were down more than anywhere else, although they had a slight recovery on Thursday with this news (which was erased and then some on Friday).

There is no doubt that lowering interest rates (what China did) and providing liquidity (what Europe did) has a positive short-term effect on stocks.  But it’s like eating sugar; that gives you a short burst of energy, but it’s not sustainable in the longer term.  Continuing that analogy, a healthy body needs real food instead of sugar, just like a healthy economy needs earnings growth instead of government stimulus.  That’s why the markets were up on the day the stimuli were announced but have since fallen lower as people realize the state of the economy as the reason “why” the stimulus was needed.

 

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Benjamin Netanyahu speaks to the US Congress:

When the Israeli prime minister spoke to Congress (without President Obama’s blessings) on Tuesday he took the gloves off and started blasting the Obama administration’s proposed treaty with Iran over its nuclear program.  As the speech went on and became increasingly belligerent, stocks softened moderately, but oil started to increase.

The fear of course is that Netanyahu’s speech portended armed conflict in the volatile Middle East.  A regional conflict wouldn’t be that big of a deal since the Middle East only represents about 3-4% of the world economy; that’s a significant amount but not a lot.  The initial concern is oil and the disproportionate amount that is produced there, and you saw how the threat of war impacted oil prices for a day (of course, the enormous glut in world oil reversed those gains quickly).

The bigger concern is that region has a tendency to draw other countries into its conflicts, especially the US.  As we know, wars are expensive and tend to be bad for the stock market as a whole (although good for particular industries like defense).  While the odds of that are pretty slim in my opinion that there is another Middle East war in the US’s future, Netanyahu’s speech showed the chances are rising, and the stock market acted accordingly.

 

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Supreme Court hears arguments against Obamacare:

This is actually a big deal.  Healthcare has been one of the huge drivers of the US economy (and the world economy) during the past several years.  The Affordable Care Act really reshaped the landscape of the industry, and was largely seen as a boon to healthcare companies who started receiving more customers because of the insurance mandate.  Additionally, the government’s subsidies of insurance for lower-income people acts as a huge financial injection from the Treasury to the pockets of the health care industry.

As the Supreme Court reviews a key provision of the law, there’s the potential that all of Obamacare could unravel (certainly something the Republicans want).  That would be bad for the health care companies for sure.  When news came out that Justice Kennedy made some comments that seemed skeptical of the challenger’s case, hospital stocks rose sharply.  But even the uncertainty surrounding all this is bad, making it really hard for these companies to plan very far into the future, and I think that’s another reason that generally you saw stocks soften this week.

 

Job up but wages stay lower:

Friday’s news was dominated by the jobs report.  The good news was that employment was up, with the jobless rate being at its lowest level in about seven years, so that definitely seems to be a good thing (although the calculation is kinda weird because it doesn’t include people who have stopped looking for jobs).  However, the types of jobs are not high-paying jobs as reflected by the fact that wages were flat.  This means that more people are working, but they are tending to be lower paying jobs which is definitely a sign of underemployment.

Overall this has to be net good news, but of course it would be better if both employment and wages were rising for the economy.  Interestingly markets were down sharply on this news, which is counterintuitive; I think it’s probably because this good news makes it more likely the Federal Reserve will raise interest rates sooner.  But of course, that would change a million more times in the next few weeks.

 

So there you have it.  A bit of a bummer of a week for the markets considering we were on a pretty sweet winning streak.  Unfortunately, except for the NASDAQ 5000 celebration (ironically, the NASDAQ promptly fell to 4980 after it hit its mark) there seems to be some developments that are genuinely concerning.  I hope you have a great weekend and I’ll see you tomorrow with my review of The Millionaire Next Door.

 

My optimism overfloweth

“The report of my death was an exaggeration.”  –Mark Twain

A couple weeks ago Robert Schiller published an article warning investors that the next couple decades are going to be tough ones for the stock market, and they should prepare themselves accordingly.  I read this and I have to say that I disagreed with him.  Professor Schiller won the Nobel prize in economics last year and is a world renowned professor at Yale; I was one of 100 students to graduate with honors from the University of Chicago’s MBA program in 2006.  It should be pretty obvious which of the two of us is just a little more credible.

The premise of Professor Schiller’s argument is that stocks are at all-time high valuations, and they have to come down.  Intellectually I agree with this, but I think he’s missing the mark in two major ways:

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Nobel laureate, Robert Schiller

 

Predicting major moves in the stock market is really, really hard

As we learned from A Random Walk Down Wall Street (I’m sure you all went out and read it after reading my incredible review, right?), it’s nearly impossible to predict when things will happen with the stock market.  In 2015 Professor Schiller is predicting we’re going to have a major correction/sustained period of flat stock prices.  Sure, he’s probably right that that will happen, but is it going to be in 2015, or in 2020 when stocks are 50% higher than they are today, or in 2030 when they are double what they are today?

I think this is where history is a good guide.  The 1980s were an awesome decade for the stock market* with returns averaging an astounding 14% per year.  As you can imagine, there were a ton of pundits saying the stock market rose too fast, valuations were too high, things just weren’t making sense–you had to get out of the stock market.  What happened?  The 1990s came along and outperformed the 1980; stocks returned 18% per year.  People didn’t realize that the computer revolution of the 80s was leading to the internet revolution of the 90s, and if you missed the 1990s investing boat because the 1980s had been so good, you were hating life.

Even look at the internet boom and the bubble that eventually burst in 2000.  In the 1990s year after year, the stock market was putting up tremendous gains.  I remember in about 1997 or 1998 the chorus of naysayers was deafening; they were predicting that valuations didn’t make sense, a bubble was building, and stocks were going to plummet.  It turned out they were right, but the plummet happened 4-5 years later.  In the meantime, the DJIA went from 6800 in 1997 to a peak of 11,200 in 2000.  Of course, the bubble burst, but the stock market only went down to 7600 (Sep 2002).  Sure the pundits were right .  . . sort of.  The bubble burst, but if you took their advice when they gave it, you would have missed out on a market that rose from 6800 to 7600 with a crazy ride in the middle.

The history of the stock market is littered with these examples; literally everyday you have some market expert saying the end is near, yet the market consistently proves them wrong.  Professor Schiller is much smarter than I am, and there probably will be a time they the stock market crashes or goes sideways for a long time.  But no one knows when that is (and I would think Professor Schiller would agree that he doesn’t know that either), and you might miss out on a great run in the meantime.

 

Innovation is always happening

Innovation is one of the main drivers of the stock market.  Companies innovate, figuring out new ways to do it better, faster, cheaper.  This leads to higher profits which lead to higher stock prices.  It was the electronics innovations of the 1950s that led to 160% increase in stocks in that decade, computing innovations of the 1980s; and internet innovations of the 1990s.  Sure you have off decades like the 1970s and 2000s, but those happen less often; even then innovation is still happening, but it’s just not translating to stock gains until later.  Is there any reason to believe that in the next 20 years we won’t have unimaginable innovations that will change our lives the way computers and the internet did?  I think those will happen and I think those will drive stocks higher.

google car

Eventually cars will drive themselves.  My neighbor just bought a Tesla and the thing can start itself, open the garage, pull out, and have the car all nice and toasty, so all Mr Grizzly has to do is get in and go.  There is no doubt in my mind that in a few years they’ll be driving themselves.  Can you imagine once that happens?  Auto accidents and drunk drivers will all but be eliminated.  Old people, blind people, pre-16 kids will have incredible mobility.  Traffic jams will fade away.  Commuters will have hundreds of hours of their life back each year.  And all this innovation will make some companies tremendous profits and their stocks will skyrocket.

Every year solar panels become more efficient and less expensive.  Soon they are going to be as common on roofs as DirecTV dishes.  Electricity bills will go down, carbon emissions will drop (also thanks to automated, electric cars from above).  The world will benefit and some companies are going to make a killing.  Amazing medical advances are happening every day; really smart people at Amazon.com are figuring out how drones are going to change the world; light bulbs are going to last 100 times longer and use 100 times less power; new methods are going to find more oil less expensively.

I’m going to be wrong on nearly all the details I listed above, but I truly believe that I am going to be right on the general message that the innovations we have in store for us are going to dazzle our minds.  And they’re going to make tons of money for the companies that do them, and tons of money for the investors who own those stocks.

 

So I respectfully think Professor Schiller is wrong.  Investing in stocks is a great investment now and will be a great investment for years to come.  In fact, I’m putting my money where my mouth is and have 95% of the Fox’s portfolio in stocks.  I would welcome Professor Schiller to respond—he’s always welcome to write a guest post 🙂 .  Of course if he does, I will become giddy as a school girl and ask that he pose with me for a picture and then autograph it.

 

*  I’ll be using the Dow Jones Industrial Average in these examples

How to invest a windfall

raining-money

We got this letter from a reader:

Stocky,

Sadly my father passed away, but he had a $200,000 life insurance policy.  My mom spent $60,000 as a down payment on a house and $40,000 for my sister’s medical school.  That leaves $100,000 left; I was thinking about going into business with a couple shady guys to start a liquor store, but my wife talked some sense into me.  So we decided to invest the money in an S&P500 index fund (VFINX). 

My question to you is, should we invest the $100,000 all at once or spread it out in smaller investments over a couple months?

Walter Y from Chicago, IL

 

I admit I may have made this letter up as a framing device, but Walter’s problem is a pretty common one.  Maybe it’s an insurance payout, a tax refund in April, a bonus check, or a bunch of cash you’ve accumulated in your checking account.  In fact, every July the Fox family faces this exact scenario when I get my bonus check.  Let me tell you my thoughts on the matter (which of course is not an expert opinion, and which looks at historical price movements but makes no prediction on future stock movements).

When I get my bonus, and what I would have suggested to Walter, is to take the big chunk of money and invest it in equal pieces over a couple months.  Vanguard and most places will let you set up an automatic investment, so in the words of Ron Popeil “you can set it and forget it.”  So let’s imagine for Walter he would invest $10,000 per week into his mutual fund for the next 10 weeks.   Why do I do it this way?  Because I’m a spaz.

If I invested all the money at once, I would be totally freaked out that I would buy at the wrong time—either I would buy the day after stocks went up 1% or I would buy the day before stocks dropped 1%.  Using Walter’s scenario of $100,000 to invest, that would mean I could “lose” $1000 by investing at the wrong time.  That would totally tie me up in knots and I would be looking at the stock market trying to find the exact right time to jump in, like a kid on the playground playing jump-rope.  Of course we know from A Random Walk Down Wall Street, that all that stuff is random so there’s no point trying to time it, but I’m not totally rational when dealing with that much money.

For the blog, I did a little analysis and found that 12% of the time stocks* lose at least 1% in a single day; if I bought the day before that happened, I’m out at least $1000.  On the other side, about 13% of the time stocks rise 1% or more in a day; if I bought the day after that I’d similarly be out $1000.

My fragile nerves just can’t take that so I want to “diversify” the timing of my purchases to even out those big ups and big downs.  This is a strategy called “dollar cost averaging”.  So as I said, initially I would have recommended to Walter that he take the cautious path, take his $100,000 and split it into $10,000 chunks, and invest those each week for the next 10 weeks.

 

windfall analysis 2

But then using the magic of spreadsheets and the internet, I decided to see what the actual data said.  I looked at every week for the market since 1950 and did a comparison of the two scenarios:

  1. Invest your entire chunk of money all at once
  2. Spread your investment evenly over 10 weeks (dollar cost averaging)

Wouldn’t you know that on average it’s better to invest your entire chunk at once?  I’ve been doing it wrong this whole time, so thank you Stocky Fox.  In fact it’s not even close—historically it has been better to do option #1 about 61% of the time.

The thinking is that historically, stocks have always gone up.  Sure there have been some rough patches, some of which can last a really long time, but the general trend is definitely upwards.  So if you wait to invest your money over a longer time period, you’re missing out on some of that upward trend.  I looked at every week since 1950 (if you were curious, there are about 3400 weeks) and on average you gain about 0.7% by going with option #1 instead of option #2.  0.7%!!!  Holy cow.  Remember that post on The power of a single percentage?  We just found a 1% coupon right there.

So Walter, my advice is to pick a day this week and invest it all in one fell swoop.  You might get hit with bad luck, but the odds are better that you’ll get hit with good luck to the tune of about 0.7% (which in your case is about $700).  On the day you do it, don’t even look at the stock market and have several tablets of Alka Seltzer on hand.

*For this analysis I am using the S&P 500 data going back to 1950.

Movie review–A Raisin in the Sun (1961)

In honor of black history month, I am posting a review of A Raisin in the Sun.  It was originally a play written by Lorraine Hansberry in 1959 which experienced significant success on Broadway, after which it was adapted into a movie in 1961.  Over the years it has appeared in playhouses around the country in many incarnations as well as being made into three films.  Walter Younger, the main character, was originally played by the incomparable Sidney Poitier and later by Joe Morton, Danny Glover, Puff Daddy, and most recently Denzel Washington.

 

Poitier in RitS-2
Walter (Sidney Poitier) trying to convince his mother (Claudia McNeil) to use the insurance money to start a liquor store

The drama centers on the Younger family: Walter, his wife Ruth, and their son Travis; Walter’s sister Benny; and Walter’s mother Lena.  The entire family is living in a two-bedroom slum apartment on the south side of Chicago (near where I went to graduate school).  Walter is constantly dreaming of making it big with some get-rich-quick scheme, while Ruth and Lena have accepted their humble lives, and Benny is soaking up all life has to offer while studying to become a doctor.

As a stroke of bitter-sweet fortune, Walter’s father who had recently died, had a life insurance policy that paid $10,000 to Lena (which today would be the equivalent of between $80,000 and $200,000 depending on how you calculate it).  Walter wants to put it towards opening up a liquor store while Lena wants to use it to buy a home and help pay for Benny’s education.

Eventually Lena puts $3500 down on a new home in an all white neighborhood for the family, but gives the rest to Walter.  She instructs him to put $3000 in a savings account for Benny and then do with the rest as he thinks best because he is the “man of the house now”.  Walter uses the whole $6500 (including Benny’s $3000) to pool with some friends to open their liquor store but is swindled when one of his partners bolts with the money.

A bitterly dejected Walter, having squandered his family’s windfall, tries to redeem himself by offering to resell the house his mother bought to their soon-to-be neighbors who are willing to buy the Youngers out (and at a profit for the Youngers) so they don’t have to have a black family among them.  At his darkest moment, Walter’s family rallies around him and Walter rejects their neighbors’ offer and the family moves into their new home.

 

There are two analogies which come to mind when thinking about this movie: first mole sauce and second a time capsule.

Mole sauce, because it’s made of something like 1000 different ingredients, and it seemed like Hansberry deliciously layered about 1000 different social issues into her intriguing play.  Race was the dominant issue of the drama—white racism against blacks most overtly, but also black racism against whites as well as black racism against fellow blacks.  You also had questions of what it meant to be a black person living in white America as well as the relationship black Americans should have to Africa.  The play also looks at gender roles, the evolving role of religion, poverty issues and the potential for upward mobility, and if all that wasn’t enough it even throws in abortion and child abuse.  All of those were relevant then and they remain relevant today.

Time capsule, because as I was watching the movie in 2015 I was asking myself “Is that really what life was like in 1960?”  Whether it’s the race issues, how women are viewed both by Walter and the women themselves, a defeatist attitude about upward mobility, or their insane views on how to use the money (more on this in a second); it just seemed like this was another world, not 50 years ago.  I don’t know if I’m naïve when I think it couldn’t really have been that bad then, or if I’m proud of our society for having come so far in the five decades.  On the surface the movie is so anachronistic but at its core it features the issues and struggles that we have today just as we did in 1960.  Very thought provoking.

Benny is the most interesting character (but also the character I get most frustrated with) because it seems all these issues use her as a foil.  She wants to be a doctor to help society and break out of poverty, but her family only sees her as the future wife of some man, preferably a rich man.  She ends up dating two men—one is a wealthy, educated black man who has completely assimilated to “white America” while the other is a Nigerian who asks her to embrace her African roots and ultimately return to her ancestor’s continent.  She wants to experiment with all life has to offer (photography, horseback riding, music) while her impoverished family can’t really afford such fickle luxuries.

And of course, any review of this movie is incomplete without a comment on Poitier’s performance.  Obviously, it’s sublime.  He creates an amazingly complex character who is at the same time oppressively pessimistic but also unswervingly optimistic; defeated by life yet playful; prideful and stubborn yet able to lead the family when it needs him most.  Many people have written many pages on the greatness of Poitier (as I have just done) and deservedly so.  Additionally, I would be remiss if I didn’t also compliment Puff Daddy for an unexpectedly wonderful performance as Walter in the most recent movie from 2008.  Who knew?

 

Combs in RitS
Puffy Daddy and Phylicia Rashad from the 2008 movie

You’ve been patient with me so far, and maybe you’re wondering, “yeah, that’s all great, but what does this have to do with personal finance?”  The movie revolves around a family that receives a huge financial windfall, and they need to figure out what to do with it.  This is actually a very common scenario in real life, and actually one I’ll dedicate next Monday’s post to.

And just like in real life, the family has all sorts of ideas on how to spend the money, ranging from quite sensible to insanely frivolous.  Lena uses a chunk of it as the down payment for a house and intends another big chunk to go towards her child’s education, both fairly sensible.  Walter wants the money to start a business which is high-risk/high-reward; of course one of the major risks there is you expose yourself to malfeasance which ultimately bites him.  Other ideas are thrown about like Lena should use the money to take a luxurious vacation (sounds like fun, but not very responsible), donate it (noble but doesn’t solve the Younger family’s problems), or even just hang the check up on the wall and look at it.

It pains me that they never consider the idea of investing it in the stock market.  Of course in hindsight maybe they were wise to avoid the 1960s (a decent decade for stocks) and 1970s (a terrible decade for stocks).  But I suspect it speaks to the lack of financial literacy and knowledge of investing in the broader population from the 1960s, and particularly for the impoverished.  This is actually a place where I think we’ve made a tremendous amount of progress as a society (more on this in a future post).  Had the book been set in 1950, 1980, 1990, or 2010, not considering the stock market would have been a costly oversight.

 

So there you have it.  I think it’s a great movie, especially appropriate as we reflect on black history month and look at its intersection with personal finance.  I love Poitier and the social issues are incredibly thought provoking.  But I feel the other characters don’t match Poitier’s excellence (tough to do).  Also, you can obviously tell the movie is an adaption of a play; the action is stilted and the scenes overly dramatic the way live performances so often are (sometimes you feel you’re watching a camcorder recording of a play, instead of a movie).  I definitely recommend it, and give it three out of four stocky foxes.

3 foxes

Week in review (27-Feb-2015)

The biggest stories this week were:  Fed speaks to congress (Tuesday, Wednesday), American cars get high rank (Tuesday), TJ Maxx raises wages (Wednesday), and Net neutrality regulations passed by the FCC (Thursday) .  Of course, there were the daily Greek gyrations, but I figured I covered that adequately on Wednesday.  It was a pretty tame week for the markets virtually flat across the board.

graphic

 

Fed comments:

Janet Yellen spent Tuesday and Wednesday testifying before Congress, and the markets were hanging  on her every word, of course waiting for any indication as to when  the Fed will raise interest rates.  As par for the course, about half the market watchers thought her comments dovish, indicating that the currently low rates would remain low for longer, while others thought her comments hawkish, indicating that a rate increase would happen sooner.

Of course, when the Fed does increase rates, it will most likely mean they think the economy is healthy enough to not to have to be propped up by the super-low interest rates  that have been present for the past 5+ years.  The markets will freak out when that happens in the short term, but it will be a good thing for the long term.

 

102447833-2015BuickRegalAWD.530x298
The Buick Regal was named best sports sedan

American cars do well:

Consumer Reports announced its annual winners for each car category, and American brands sat atop three of the ten categories, including Tesla being named best overall car.  This is important for a couple reasons: First, it shows that the domestic car industry is alive and well, creating really strong offerings.  This will of course lead to greater sales which will lead to higher profits and ultimately rising stock prices.  So that seems particularly good for the US automotive industry that was so bad for so long.

Second, the report really highlights the amazing technological advances that are going into all these cars.  These cars (and trucks) are becoming computers integrated into our lives in amazing ways.  They’re making driving safer and more convenient.  Over the next 10 or so years, I think we’re going to see a major transformation in the auto industry, especially as self-driving features become mainstream, which is going to be amazing for society but also tremendously profitable for the companies who can put it together.  Also, it doesn’t hurt that tremendous innovators like Google and Apple are entering the fray.

 

TJ Maxx chart
TJ Maxx announced the pay increase on Wednesday along with its earnings, which led to a sharp increase in the stock price

TJ Maxx raises wages:

On the heels of Wal-mart’s announcement last week, TJ Maxx announced that it was following suit in raising the wages of their lower-paid workers to $9 per hour.  In contrast Wal-mart’s experience, TJ Maxx’s stock rose sharply on the news; of course, that was the same day they announced really strong quarterly earnings.  So it’s hard to tell if the market thought that TJ Maxx’s wage decision was a good one, or if they thought it a bad one which was masked by the otherwise good earnings news.

Either way, it’s undeniable that now this movement has a little momentum.  Wal-mart and TJ Maxx are just two of thousands of companies that have low-wage workers, but now there are two more companies who are voluntarily raising their wages than there were before two weeks ago.  If this movement continues to grow, it will certainly have important implications for the stock market but also, more importantly, society as a whole.  It will pressure the profits of those companies (a bad thing for stocks), but it will also put more money in the pockets of a segment of the population that is mostly likely to shop at those stores (a good thing for stocks).

Also, probably the largest implications for this are appealing to my libertarian roots.  Wal-mart and TJ Maxx have voluntarily made these moves.  No government intervention was required (although perhaps it was the threat of government intervention, but I doubt that given our divided government).  Will this show that when left to their own devices, companies will find win/wins for themselves and their employees?  I hope so.

 

Net neutrality:

This is one that definitely will be a big deal; the only thing now is no one really knows if it will be a big deal in the positive or negative direction.  This legislation just passed by the FCC imposes rules on internet carriers similar to those placed on phone carriers.  It has a lot to do with how internet carriers now cannot provide preferential access to certain websites, etc. (although I must admit that I find the legislation confusing).

The reason I think this is so important is that this is one of the first steps in governing the largely “unregulated” internet, and that poses the question: “Is that a good thing?”  On the one had you could say that the internet has grown up and is now such an integral part of our lives and our economy that it has to be regulated to ensure fairness, safety, quality, etc.  On the other hand, you could say that the internet has grown to be so valuable because it has been given a free hand to grow as the open market dictates, and government meddling will just mess all that up.

I am a strong believer in free markets, and I side with the idea that less government regulation tends to be better.  These changes make me a little apprehensive.  The regulations the FCC is imposing are similar to the ones imposed on long-distance phone carriers 80 years ago, so reasonable people may wonder how appropriate that is.  Also, this is happening in a thriving part of the economy that has provided amazing technological advances that have given huge benefits to society, so the stakes are pretty high.  I just hope we don’t look back on this and say this is one of the things that hobbled the internet.

 

So there you have it.  Greece and the Fed took center stage and spent a lot of time saying stuff that didn’t have a lot of substance to push the market one way or the other.  But you also had some pretty interesting stories pushing stocks both higher and lower.  At the end, we ended up pretty much where we started, and isn’t that just the way with these things so often.

The skinny on the Grexit

Cracked euro and Greek flag

 

“I’m sorry but this relationship just isn’t working.  It’s not me, it’s you.”

The Greek financial crisis continues to dominate the financial press.  Last Friday, when the European finance ministers reached a last-second agreement, the Dow Jones Industrial Average rose over 100 points.  Monday there started to appear fissures among Greek legislators with some thinking Alexis Tspiras gave too much, causing markets to drop.  Then on Tuesday the lenders approved Greece’s plan, and the markets surged.  So what is an investor to make out of all of this?  In this post, I’m going to break down what I think will happen and how that will affect us as investors (as always, this is just my opinion and I am not guaranteeing the future).

As I said in my Feb 13 weekly review, there are broadly three options on how this situation can play out:

  1. Greece uses the loans as a bridge to reforming its economy so it can reestablish itself as a self-sustaining country which can support itself without foreign intervention.
  2. Germany and the European community continues to subsidize the Greeks in spite of their failure to drive the sufficient reforms necessary to become fiscally solvent.
  3. Germany and Greece don’t agree, Greece defaults on its debt package, and they will ultimately leave the Eurozone–Grexit.

 

The first option—Greece stands on its own—is the one everyone has been hoping for, and really the reason for all the effort in the first place.  Yet, it also seems incredibly unlikely.  Greece spends too much money and it takes in too little in taxes.  Their pension system is incredibly generous and expensive; some estimate that last year 40% of the people who started collecting pensions were below the official retirement age.  Their public sector is enormous and inefficient, and their tax system is corrupt and totally ineffective with so many loopholes it reminds you of Swiss cheese (thank you, I’ll be here all week).  But most damning is they just aren’t very productive.  Quick, name a product that is made in Greece that you’d want to buy.  Not easy to do.

Put all that together and it’s a total recipe for disaster that has led us to where we are.  That’s not to say a country can’t dig itself out of this hole with the proper motivation and a willingness to sacrifice–Ireland comes to mind as a country in a similar place that has started down the slow, long, painful path to recovery–but the Greeks seem to have neither.  Just a month ago they elected a prime minister who ran on the platform that he would repeal all the austerity and reform measures that were imposed on Greece to get them back to self-sufficiency.

If Greece were able to pull this off, then it would be a huge boost to all the stock markets, especially the European markets, and most especially the Greek markets.  But I just don’t think the Greeks have it in them.  I hope they prove me wrong.

 

The second option—Greece continues to get loans without meaningfully improving—seems to be where we have been for a while now.  If you accept the reality that Greece will never be able to right itself, then this seems like the best option except for ONE MAJOR PROBLEM—eventually the Germans and the rest of Europe will get tired of subsidizing Greece’s reckless spending problems.  And by the looks of it, “eventually” might be soon.  Just like the parents of their 26-year-old, unemployed son living in the basement are one day going to say “enough is enough” so that will happen with the Germans and the Greeks.

So long as the loans keep coming, Greece has shown very little motivation to make the hard choices to get better.  Remember in 2012 when Tspiras and his Syzria party first started making waves, he basically was calling Germany’s bluff, saying that the loans would continue even if Greece rolled back the reforms because no one was willing to kick Greece out of the Eurozone.  Incidentally, isn’t that just a massive “screw you” he gave to the Germans?

This whole drama started 7 years ago and has Greece been able to fix its problems in that time . . . no.  Germany and others continue to lend money which creates a drag on their economies and lowers their stock markets, while Greece takes the money and fritters it away.  Believe me, I would love to be partying all the time while someone else pays the tab, but life isn’t like that.  If we continue down this path, I would expect returns from European markets to continue to be lower than those in the US, as has been the case for the last five years.

 

The third option—Greece leaves the Eurozone—seems to be eventually where we end up once Germany cuts up Greece’s credit card–Grexit.  Since no country has ever left the Eurozone, no one really knows what will happen.  People with a vested interested in keeping the status quo use scaremonger tactics to paint a picture of economic catastrophe if this happens.  But what would really happen if Greece left the Eurozone?  Here’s my take:

Undeniably, it would be bad for Greece and anyone investing in Greek stocks, really bad.  They’d have to introduce their own currency which would start trading against the Euro, and because of the shambles of the Greek economy it would depreciate rapidly.  Greece would experience huge inflation and imports would become much more expensive which would have a huge negative effect on the quality of life for the Greek people.  Also, when they went to borrow money internationally, their past track record would make it so they would only be able to do so at interest rates much, MUCH higher than they are getting now from the subsidized loans from Europe.  Greece would tumble into a huge recession that would make the past five years look like a day at Mykonos (again, I’ll be here all week).  After many, many years, things would start to normalize but Greece would be firmly entrenched in the ranks of a 3rd world economy rather than a peer among Europeans.  That would really suck if you were Greek.

The major unknown is what would happen to the other European countries in the Eurozone.  Probably for a little bit it would be rough sailing just because the maneuver of a country exiting the common currency has never been done before, but what would really change over the long-term?  Would Seimen’s x-ray machines (Germany) be any less accurate; would Heinekens (Netherlands) taste any less good; would Michelin tires (France) be any less durable; would Ferraris (Italy) be any less of a status symbol?  No, they’d all maintain their competitive positions, continue to sell, and maintain the value of their stocks.  After the brief hiccup when Greece leaves and things get settled, the European economies would probably be even stronger because they wouldn’t be dragging Greece along with them.  Sure, their imports to Greece would be hurt, but remember the Eurozone is about the size of the US economy while Greece’s economy is about the size of Connecticut’s; not a huge deal in the grand scheme of things.  I would predict that within two years (and probably even less), the European stock markets would be higher than they would on the day of Grexit.

As far as the rest of us go, the whole Greek saga really has no bearing.  As I mentioned before Greece is tiny in terms of its economy.  If/when Greece exits the Eurozone and its economy implodes it will go unnoticed except by our news organizations which are going to have to find something else to talk about, but that’s really it.  In fact, because Grexit will be good for Europe, it will benefit the other global economies just because we will have a healthier and stronger Europe to work with.

 

So there you have it.  That’s my take.  The sooner we face reality, the sooner we accept that Greece just isn’t capable/willing to support itself, the sooner we’ll be able to move forward.  And that moving forward will help all our economies and be positive for the stock market.

The power of a single percentage

2014-02-18 (1 percent)

“How can something so small be so impressive?” –Belinda Heggen

1% doesn’t seem like a lot.  It’s the extra sales tax my city adds, hoping I don’t notice it.  It’s the maximum amount of gross stuff food companies can put in packaged food without having to tell us (I don’t know it that’s true or not).  But in investing 1%, while so easy to overlook, can make a huge difference.  Here we’re going to find out how we can get that 1% to help us.

Let’s go back to my neighbors, Mr and Mrs Grizzly.  Each year they will save $10,000, investing it in a stock index mutual fund with an expected annual return of 6%.  After 30 years, they expect to have $790,581 saved (good time for the disclaimer that I am not predicting future stock performance, just giving an example), a tidy little sum to help see them through their golden years.

However, Mrs Grizzly starts playing with her spreadsheet and changes the annual return from 6% to 7% just to see what happens.  She’s astounded to see that the $790,581 that she gets with a 6% return balloons to $944,608 if she assumes a 7% return; that increase in the annual return of 1% led to an increase in her nest egg of 19%.  Tempting fate she sees what happens with an 8% return: $1,132,832.  She’s a millionaire now.  Cranking the return up to 9% made her nest egg $1,363,075; just increasing her return 3% nearly doubles how much she and Mr Grizzly will have to retire on.  Ladies and gentlemen, welcome to the power of compound interest!!!

Percentage graphic

The point here is that a seemingly small 1% change in your investment return can make a huge difference over time.  By tailoring your investment strategies to collect as many “1% coupons” as possible, you can substantially increase, even double, the value of your nest egg.

So how do we get those higher returns?  Most people will default to higher stock returns: “It’s a no-brainer.  Instead of investing in the stocks and mutual funds that return 6%, let’s invest in the ones that return 7%.”  Unfortunately, after reading A Random Walk Down Wall Street we know this isn’t so easy.  For any given level of risk, our investment return is probably going to be what it will be.

Now that changing the actual investment return is out, what are our options?  Fortunately there are a lot of other things that affect our total return beyond just what our investments give us.  We’ll dive into each one of these with its own blog post, but a few to think about at a high level are:

  1. Mutual fund management fees: Each year mutual funds charge between 0.05% all the way up to 1.50% or more for management fees.  Going from high-cost mutual funds to low-cost funds can easily get us a 1% coupon.
  2. Financial planner fees: There are a lot of people out there who are more than willing to tell you how to invest your money for a small fee.  Except that fee doesn’t tend to be all that small: about 1-2% of your total assets.  Do-it-yourself investing can absolutely give you that 1% coupon, and the results you produce will probably be similar to those your investment adviser would.
  3. Being smart with taxes: You know Uncle Sam is going to take his cut.  However, you can delay when he takes his share with IRAs, 401k’s, etc.  This allows you to keep the money longer, and it allows to you be taxed on the money later in your life when you will probably be in a lower tax bracket.  Being smart with your taxes can easily get you a 1% coupon.
  4. Take the “free money” offered to you: Many of us work for companies that match 401k contributions.  Except they only give you the extra money if you invest in your 401k.  So at least putting in up the minimum amount of get the match can absolutely give you one or two 1% coupons.
  5. Proper asset allocation: We all know that some of your investments should be in higher return, riskier investments like stocks and some should be in lower return, less risky investments like bonds.  Properly assessing your portfolio to know how much you already have in less risky investments (especially things like pensions, Social Security, your home equity, etc.), can allow you to safely put more money in investments like stocks.  Over the long term, this could easily increase your return each year and get you a 1% coupon.
  6. Fully investing: So many people I talk to have $10,000 or $20,000 or $50,000 in their checking account that they’re “just waiting to figure out what to do with it.”  These are certainly Champagne problems, but they are also fertile ground to find 1% coupons.  Just taking that money and putting it in a bond fund instead of a checking or money market account could easily give that extra 1% or more; investing in a stock fund will provide even greater returns over the long run.

Those are just a few examples of how you can squeeze an extra 1% or more from your investment returns.  You’ll notice that none of those strategies include “outsmart Wall Street and pick the stocks that are going to do the best.”  I’m not that smart; I wish I was because then the Fox family would own its own island in the Caribbean next to Johnny Depp’s island.  These are all really simple strategies that anyone can do, and each of which takes less than a couple hours to set up, and can lead to hundreds of thousands of dollars over your investing lifetime.  The Fox family has benefited by these little strategies probably to the tune of 4-5% extra return each year over what seems typical among your average American investor, and that has equated to hundreds of thousands of dollars.

So here’s the bottom line:  As you read this blog, we’ll constantly be finding “extra 1% coupons” that you can redeem to increase your overall investment returns.  As Mrs Grizzly showed, even one of those can add $150k to your nest egg.  If you can gather two or three or even more, you can double your nest egg.