Let’s create a visual here. Picture an editorial cartoon of a Prius driving down the road. In that Prius are two graduates hanging out the windows drinking from what looks like vodka bottles, but instead of vodka, the bottle says “Power.”
There is also a sign under the window of these graduates that says “Young pinkies from Columbia and Harvard.”
And in this Prius, there are two others hanging out the back seat throwing bags of money and gold coins to anyone they pass. Under them is a sign that says “Depleting the resources of the soundest government in the world.”
Now alongside the road is a man with a sign that says “Plan of action for U.S.: Spend! Spend! Spend! Under the guise of recovery—bust the government—blame the capitalists for the failure—junk the constitution and declare a dictatorship!”
Now consider this visual. Does this sound like today? Does this sound like everything we’re seeing from Wall Street and Congress today?
Well surprise, this is an actual editorial cartoon published in 1934 in the Chicago Tribune. To view this illustration, click here. Our point is that it is the same feeling of hopelessness. The crisis is different, but the garbage is the same. Someone is always trying to kill us. Someone is always trying to change the way we live our lives. Another point to keep in mind, when that cartoon was published in 1934, it took 13 years for the economy to return to the nominal level of GDP that it had before The Depression. Today’s economy has already reached that point.
The worst thing you can do with your investment policy is think it is different this time around and radically change your plan.
Let’s look at some numbers. Let’s say when you retire you want to have $60,000 after tax to spend. Let’s assume you have 30 years until retirement, and assuming a 4% inflation rate, at age 65, you will need $2.5 million in the bank to carry you from ages 65 to 90.
That math is simple, but the bigger question is how much do you have to save to get there? Assuming you can get a 10% return on your investments, you need to save $15,500 a year.
Now say you have just 10 years until retirement. You would need to save $72,000 a year just to have $1.1 million by the time you’re 65.
In order to reach these numbers, your investments need to be long term and earn well more than U.S. Treasuries, which are paying 0.3% for one-year treasuries; 3.4% for 10-year treasuries, and 4.2% for a 30-year treasury. With a 30-year treasury, you are barely beating the normal rate of inflation.
In our opinion, the only way to generate the type of return desired is to be invested in common stocks. Yes, there are other ways to achieve this—real estate is an option, but real estate is a job that requires continual management and maintenance. Yes, we own our own homes and even our own building, but we also pay for maintenance. We make a living doing other things than property management and labor that comes with real estate. Our point, however, is you simply cannot achieve your goal of a 10% return with treasuries or municipal bonds. Those investments are designed to preserve capital, not grow capital.
Another issue with holding treasuries for the long term is changing interest rates. If you buy that 30-year bond paying 4.2%, and interest rates moved up 1%, you’d loose 15% on the bond. If interest rates increased 3%—which happened just 10 years ago—you’d lose 36% on that bond. That sounds like a really bad bear market. Now is not a good time to buy bonds. You need to invest in stocks, but so many investors say, “I can’t take it! I can’t stomach the fluctuations.”
Let’s now take a look at an academic example: Dollar cost averaging is the process of investing the same amount of money into and investment at a consistent interval over a period of time.
You have $500 to invest in the market, and right now your stock is selling for $5 a share. You invest and buy 100 shares. In year two, you again invest $500, but now the market is down, and your stock is selling at $2.50 a share, so you receive 200 shares. In year three, the market is down 90% and your stock is selling for $1 a share, yielding you 500 shares. Come year four, the market is up, but your stock is selling for $2.00 a share, and you buy 250 shares for your scheduled $500 investment.
Now consider your average price per share purchased by dividing your total investment of $2,000 by the number of shares you own, 1,050. You have averaged $1.90 per share. You have actually made money even though the market is down 60% because 1,050 shares at the current price of $2.00 a share is worth $2,100.
Now come year five, and the market is up again and your stock is selling for $5.00 per share, so you buy 100 shares with your $500 investment. You now own 1,150 shares valued at $5,750. You have only invested $2,500 over the past five years. You have doubled your original investment in a market that essentially went nowhere. This equals a return of 14% on your investment.
As a financial advisory firm, we are regulated so our published performance numbers are verified. However, our clients historically generally do better than our published numbers because we dollar cost average.
We also advise that you do not want to carry a stock investment for less than 10 years because of the short-term risk. Over the last 20 years, the S&P compounded rate of return was 8.2%, while the average investor only made 3.2% because they all sold at the bottom. The reason for the 10-year time horizon is that you never want to be forced to sell at the bottom. You want to be able to wait for a recovery. If you need your money in the next 10 years, you cannot buy stocks with that money.
When you are invested in stocks, why not consider some high dividend paying investments to make you feel better? For example, McDonald’s Corporation (NYSE: MCD) yields a little more than 3% in dividends, annualized. If you bought McDonald’s in 1990 at $7.94 a share (split adjusted)—forget appreciation as it is selling for more than $60 a share today—it paid $2.10 in dividends; therefore, the yield on that is 26.5% on your original investment.
When you consider dividend paying investments in your portfolio, all of a sudden a 10% average return isn’t so unobtainable, if you want to reach that $60,000 after tax in retirement. This is why we recommend taking a long-term approach to investing.