[Disturbing]NYTimes: Investment returns depend largely on when you start and end

[zazz]

This is my first post. I've been a lurker for awhile but as soon as I read the article I had the overwhelming urge to register and post this.
"After accounting for dividends, inflation, taxes and fees, $10,000 invested at the end of 1961 would have shrunk to $6,600 by 1981. From the end of 1979 to 1999, $10,000 would have grown to $48,000. "
http://www.nytimes.com/interactive/2011 ... aphic.html
Also the 20 year median returns (after inflation, fees and taxes) is 4.1%. Much different than the 10% figure that most people believe in and featured in many personal finance books.
Some initial thoughts:
* This is very bad news for the typical American. It takes a lot to build a career these days - decades of networking and climbing the corporate ladder and often grad school. "Peak earning years" occur between 35-55 (source at bottom).
Lets say Joe Americano's salary peaks at age 45. He retires at 65. Like most of his countrymen, he wasn't that fiscally responsible while he was young so the savings from the peak earning two decades will form the vast majority of his nest egg. So a 20 year investment horizon is actually quite realistic.
If this happened for Joe around 1961, he'd be screwed because his investment would have endured a negative two percent return until 1981.
Timing is everything. Even a 20 year investment horizon is not enough to save Joe from the power of coincidence.
* "After 60 or 70 years, returns are relatively stable, but this time frame is longer than the relevant horizon for many retirement plans." - This IMHO is a big argument for some sort of pension system. Some people are born at the right time when their earnings / retirement savings coincide with an economic boom. It makes sense to pool some of society's temporal risks together.

[AlexOliver]

Shouldn't you be dollar cost averaging anyway? Seriously, who dumps $10k into the stock market at once and never add anything to it?

[TheWanderingScholar]

I agree with Alex, also even during a down market there is still businesses that will still largely be not affected, like Walmart, and McDonalds.

[BennKar]

That negative return is normalized against inflation. I suspect that in nominal terms the $10,000 increased quite a bit. And given that, what do you expect a person to do with his investment? Put it in savings where for most of the period mentioned the savings rates were almost as bad as they are today? If the investor did that, they would have been even worse off than investing.
That said, Social Security is a type of pension system, though a poorly funded one. And as mentioned above, your 45 year old isn't doing a one time investment, he's doing DCA, which should really work in his favor unless the drop is all at the end of 20 years (which isn't normally the case, except in 1929 & 2008). If you want to be afraid of investing, go right ahead. I'll stick with managed funds and my personal picks.

[MossySF]

Sometimes you eat the deer. Sometimes the lion eats you.
But if you don't go out to hunt, you surely will starve.
Life is unfair. Get used to it.

[jacob]

None of this is surprising to me.
There are several popular delusions though:
1) Diversification removes all risk. Wrong, it doesn't remove systemic risk.

2) Asset allocation removes all risk. Wrong, the widespread use of allocation models means that asset types become correlated so there's nowhere to hide.

3) Everything works out in the long run. Wrong, the long run in the stock market for high valuation levels is often 60 years or more. For such a long run, people are dead before their portfolio recover.

4) Dollar cost averaging produces superior returns. Wrong, it ONLY works if the final price is higher than the "harmonic average" price.
Many seem to suffer from the idea that there's such thing as a free lunch in the market. There isn't. Any good idea is eventually turned into non-profitable noise.

[Mo]

I suggest that very few people know their rate of return in real terms (net of taxes and inflation) over a period of more than 5 years-- it's quite difficult to figure that out.
One thing about ERE that really appeals to me is that I am not depending on 30 years of compounding returns at some mythical rate a fidelity guy punched into a calculator in the late 1970s. The short time-frame required with a very high savings rate reduces my dependence on a potentially unattainable long-term average rate of return.

[M]

This doesn't really surprise me. I doubt this surprises most people on this forum, actually.
Mossy pretty much summed up my feelings on the subject. Someone who never tries is certain to fail. Of course, there are other ways to skin a cat as well. Nothing says that you have to work for money and then put all of your money into the S&P 500 either. There are other ways to make passive income...

[MossySF]

I created a similar graph for bonds:
http://personalbizfinance.com/pbf/data/ ... n_Out.html
Goes to show the only guarantee you have is to keep your expenses low. Like the saying goes -- a penny saved is a penny earned -- so if you choose not to spend $100, you've taken zero risk to "earn" that $100. By comparison, I don't care if you go stocks, bonds, reits, commodities, dividend payers, flipping houses, baseball cards, cabbage patch dolls, tulip bulbs, indian tea -- investment risk means the possibility of losing money even over the long run of your entire lifetime.

[dpmorel]

Don't forget the opposite effect of "a penny saved is a penny earned".
Every $100 of monthly cost removed from a budget = $24,000 return over 20 years. Hows that for a 20 year return!!!

[dragoncar]

Don't forget that, considering taxes, a penny saved is 1/X pennies earned (where X is your marginal tax rate).
Of course everything depends on where you start and end. If I was born in the age of pensions, I wouldn't have needed to invest anything. If I were born in the future, I would have a flying car.

[orinoco]

I think it has little to do with timing but how you invest. Somebody somewhere is always making money.
5 years ago I was offered the chance to see a financial advisor by my bank. I had never thought about money before & was taken in by the sales pitch that I should be investing in the stockmarket & that it was silly for me to have so much money sitting in cash accounts.
I took out two investment products.
A Stocks & Shares ISA where I bought into a fund that mostly invested in FTSE 100 companies, I funded this with regular monthly payments as per the Dollar Cost Averaging technique which was sold to me as a way to spread risk, I still remember her exact quote now which she said waving her hand across a graph of the FTSE's performance over the previous year, "Because you are making a regular payment each month you will always hit some of the troughs." At the time (again I can only plead stupidity) I didn't twig at the time that I would also hit some peaks.
DCA sounds good, but it is a poor substitute for simply buying low & selling high. I think some people tout DCA because it is a lot easier than taking the time to understand what 'low' & 'high' really are.
I also put many thousands of pounds into a Guaranteed Investment Plan which I consider to be the worst financial but the best educational decision I have ever made. It sounded sooo simple. Put loads of money in & if we look at previous data you could see an AER in excess of 7.3% just as long as the FTSE finishes the 5 year term higher than at the start. If it finishes lower you get all your principal back - you lose nothing!
I managed to cut my losses earlier this year & over the 4 years the money was invested I made an astounding 0.3% ROI (that's over the term, not AER).
Through this catastrophic foray into the world of investing I have accumulated a very healthy understanding of inflation, I have a much better idea of what constitutes 'high' and 'low' in the FTSE 100 & no matter how many academics may try to tell you otherwise, I know that investing is nothing more than a euphemism for gambling.
I recently had another invite from one of my banks for a financial review. I thought it might be fun & sat down with an expression which probably said, "Go on then. Try & advise me!" but disappointingly & to the guy's credit he just looked at my details & told me I had it all covered, that there was nothing he could do for me, but would I like a mortgage?

[DividendGuy]

That graph doesn't do much for me. When share prices in companies I own go down I simply increase my holdings as long as the fundamentals stay the same. The market is not always effectively priced and you just have to know that going in.

[RobBennett]

I encourage you to think this through a bit, Novice. I understand where you are coming from in thinking on first impression that this is bad news. I have been studying this sort of data for nine years now and have come to the conclusion that this is really wonderful, wonderful, wonderful news.
What that chart is telling you is how to avoid 80 percent of the risk of owning stocks. 80 percent of the risk comes from following a Buy-and-Hold strategy (that is, staying at the same stock allocation regardless of how high priced the market is). If you give up on Buy-and-Hold, you're set.
The chart is telling you when stocks pay amazing returns (when prices are low) and when stocks pay horrible returns (when prices are high, like today). You're going to be seeing both sorts of markets during your investing lifetime. Why not just load up on stocks when the returns are far, far higher than the average of 6.5 percent real and avoid stocks when the returns are far far lower than the average of 6.5 percent real?
Do that and YOU will be earning a return of a good bit better than 6.5 percent real over your investing lifetime. And YOU will be able to retire many years sooner as a result.
This always works, by the way. For as far back as people have been keeping records.
Rob

[Chad]

Jacob is dead on.
All of this just shows that Buy and Hold is a bad idea. You have to work at your investments. Of course, Buy and Hold is what everyone is told to do.

[dragoncar]

Rob, how do you predict when returns will be above or below the average? If you buy when last years returns were above average, the next year could still be above average or it could reverse. You could, like a gambler, assume that the longer prices have remained above average, the higher the chance they will fall. But if prices are high long enough, the average will rise.
Note: edited substantially

[RobBennett]

"Rob, how do you predict when returns will be above or below the average?"
I use a calculator at my web site called The Stock-Return Predictor, DragonCar. The calculator runs a regression analysis of the historical stock-return data to reveal the most likely annualized 10-year return for the S&P index. For example, in 1982, when stocks were cheap, the most likely annualized 10-year return was 15 percent real. But in 2000, when stocks were priced insanely high, the most likely annualized 10-year return was a negative 1 percent real.
http://www.passionsaving.com/stock-valuation.html
What trips up lots of people is that it's not possible to effectively predict returns one or two years out. You have to go 10 years out. The reason is that investor emotion (which is unpredictable) is the dominant influence on returns in the short term but the economic realities (which are highly predictable) become the dominant influence in the long term.
Rob

[Concojones]

I agree with Rob about knowing when to invest. I'd just look at (Shiller) P/E's. Actually, I don't have the patience to hold out for 15 years until P/E's normalize. Even in these expensive times, there's value to be found (undervalued companies).

[photoguy]

The article is misleading because it is assuming the fiction of going all in and all out at only two dates. Most people accumulate over their entire careers and likewise spend down the portfolio over a retirement spanning decades.

[MossySF]

@photoguy
I made a new script that models a lifetime portfolio:
http://personalbizfinance.com/pbf/data/ ... art_end.pl
And I have one that is single date in/out but with broad asset allocation options:
http://personalbizfinance.com/pbf/data/ ... art_end.pl