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The Stock Market – The Second Biggest Financial Scam of the Twentieth Century, Part 2 of 2
Stock markets in stages, promising higher returns than older bonds and money market accounts; Thus, the stock market became the destination of choice for retirement savings and Wall Street responded by increasing its offerings to retail consumers through mutual funds. Before the year 2000 it was not unusual to hear that the S&P had returned 16% over the previous 10 years. Looking at the returns of one of the most famous index mutual funds, the Vanguard 500, its return since its 1976 inception is 11.75%, you get a 1-year return, -2.41%, a 5-year return, 11.89% and a 10-year return of 5.06%. These are average returns and not actual returns. Let’s look at a $1 increase in the legendary High Fly Fund as an example. High Fly posts a 50% gain in one year and your dollar grows to $1.50. The next year it posts a 25% loss, now your investment is worth $1.125. The average return for high-flyers reported by mutual companies is 12.5%, but that’s not your actual return. If you factor in inflation your real return or compound annual growth rate (CAGR) is worse than 6% per year.
Is 6% acceptable considering the risk an investor takes while investing in the stock market? David F. Swenson, CIO of the Yale Endowment, explains investor risk in his book, Unconventional Success, when he says: “Equity owners get paid after corporations have satisfied all other claimants. Equity ownership represents a residual interest. Such stockholders carry increased risk. They rank high in the company’s capital structure. position than the corporate lenders who enjoy.” He says “the difference of 5.0 percentage points between stock and bond returns represents the historical risk premium, defined as the return to equity holders for accepting risk above the level inherent in bond investments.” Mr. Swenson’s comments and calculation of the risk premium were based on a compound annual return on the stock market of 10.4% compared to a 5% bond yield. 10.4%-5% equals a risk premium of 5.4%. Unfortunately I have not been able to find a CAGR (compound annual growth rate) calculation that matches Mr. Swenson’s. I found several examples of average returns that correspond to a 10.4% average growth rate but not CAGR. The reason this is important is that all other savings vehicles are quoted by CAGR. Your savings account, bond and money market account are all quoted by CAGR or its equivalent, annual percentage yield (APY). To determine where to allocate your funds, you should compare apples to apples, not apples to oranges. You can guess that the CAGR for the stock market is low.
A quick look at the CAGR calculator for the stock market at moneychimp.com shows an average return of 9.71% from January 1, 1975 to December 31, 2007. You realize that return only if you invest in the market the whole time. What if you started investing in the 1980s? The numbers look the same. If you started in 1985 your returns look a little better. By 1990 the CAGR fell to 8.21%. If you start in 1995 your CAGR goes to 9.32%. If you start investing in 2000 your CAGR drops to minus 0.06%! If you remove the past 7 years of results from the S&P performance and track performance from January 1, 1975 to December 31, 1999 the CAGR was 13.03%. When the stock market is good, it’s great, when it’s bad, it’s downright miserable. For the record, there has only been one 9-year period from January 1, 1950 to December 31, 2007 in which the average return for the S&P was 16.14% and the CAGR was 15.32%: the period from January 1, 1990 to December 31. , 1999.
It should be clear from these numbers that your return depends not only on how long you stay invested in the market but also when you start investing. In fact, older bond investors have outperformed stock investors over the past 7 years.
An investor in the 1990s will have a very different view of market performance than an investor in the 2000s.
Mr. Swenson’s book is a must read for anyone investing in mutual funds, he makes a compelling case explaining why actively managed mutual funds are a money-losing proposition for investors and why a balanced portfolio based on six solid asset classes makes a winning combination. For investors.
How can I call the stock market the second biggest financial scam of the twentieth century if I’m quoting numbers that look pretty good on its face? For four reasons:
1) Because the true CAGR going back to 1950 is a very low 7.47%. As long as the market achieves a CAGR of 9.71%, it would take the average American worker 25 years and one month to save $10,000 per year to accumulate $10,000 in wealth, and 29 years and 2 months if forced to accept long-term market returns. . These numbers leave very little margin for error for the average American worker. Retirement projections for the most part are based on returns that have existed at only one point in the history of the stock market since the 1950s.
2) Because the same laws that make it easy for individual investors to transfer their money to the stock market also mandate a return at a certain time, which all financial pundits call a money-losing strategy, market timing. In other words, the law governing tax-deferred savings forces retirees to time their exits once they start withdrawing at age 70 and a half.
3) The time horizon to get a meaningful profit from the market is really long, at least 30 years. To quote Mr. Swenson, “Bonds and cash returns can exceed stock returns for years on end. For example, from the market peak in October 1929, it took stock investors fully 21 years and three months to match the returns generated by bonds. Investors.”
Charles Farrell, a consultant at Northstar Investment Advisors in Denver, used data from Morningstar’s Ibbotson & Associates to analyze 52 rolling 30-year periods, starting in 1926 and ending in 1955 and ending in 1977 and ending in 2006. Six. Mr. Farrell calculates that, on average, you’ll get 8% of your final wealth after the first decade and 32% after the second. In other words, 68% of the total was accumulated in the last 10 years.” (Wall Street Journal, Jonathan Clements November 21, 2007)
4) Because financial pundits, gurus and Wall Street current marketing strategies treat investing in the stock market as money, the money out offer hides the real risks of investing and the time horizon needed to accumulate wealth. In other words, the money needed for retirement should be invested for an extended period, around 30 years. No loan can be taken against it. It cannot be used to buy a house, a car, pay for college or a child’s wedding.
This retirement can be availed only for 30 years. Any needs other than retirement savings must be paid for from additional sources. Most people lack the financial education to understand this and blindly follow the market returns in the hope of a big score.
Fortunately there is a simple solution, but a very simple solution like this requires a job and financial education. I will present this simple solution in Part 3 of this series.
Disclaimer: This is a thought-provoking article based on real-world examples, articles, books and websites that are readily available to the public. This article is not intended to provide investment advice. Any actions you take in the market should be the result of your own financial education and consultation with a licensed professional. Financial calculations were completed using the savings goal calculator found at Bankrate.com unless otherwise indicated.
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