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Should I Stick with Stocks?

mattress Last time, we talked about a new trend – people stuffing their mattresses the 21st century way. Baby boomers seem to be the main group behind this trend. They are buying treasury bills and gold coins as safe harbors from the volatile stock market.

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It’s understandable that baby boomers are looking for alternatives because many of them are so close to retirement.

But what if you’re not about to retire … should you stick with stocks?
We’ve heard a lot about how the recent decline in stock prices has wiped out all of the last ten years worth of gains. So it’s a really good question. We decided to do some analysis of our own.

Before we start, allow us to make one disclaimer: We’re going to provide an example to help you understand how the market works. Your decisions about your portfolio should be based on your specific situation. We recommend that you talk with a certified financial advisor to help you with that.

Stocks and Certificates of Deposit

To keep it simple, we looked at just two assets – stocks, represented by the S&P 500 (Source: Yahoo! Finance) and risk-free investments, represented by one-month CDs (Source: Federal Reserve) in FDIC-insured institutions.

There may be better assets to invest in (e.g. a broader stock market index), but we still felt that these represented risky assets and risk-free assets relatively well. We were curious about what has happened in the past, looking at various scenarios, with these two assets. This is a good place to insert a couple of caveats:

  • We are looking at historical numbers. We’re not psychic nor do we possess any other ability to project the future.
  • We used nominal pre-tax rates of return, so inflation and taxes have not been factored in to the returns we’ll discuss.

The last ten years
When we look at the last ten years (going back from December 31, 2008), we see that the stock market underperformed its historical average through almost the entire decade.

The best mix of these two assets for the last ten years would have been no mix at all. Investing 100 percent in CDs provided the best return. Even then, the return was not that great: 3.62% per year by our calculations. The worst return, as you might guess, was being 100 percent invested in stocks over the last ten years. They lost about one percent per year.

What about prior ten-year periods?
One ten-year period isn’t all that instructive. So we went back ten more years (January 1, 1989 to December 31, 1998) and looked at those returns. The highest returns in that period came from a portfolio of 100% stocks, which returned 17.28% annually.

So stocks are one for two. Let’s break the tie and go back another ten years. Can you hear the disco music playing?

A portfolio that was fully invested in stocks delivered the best return in that period (January 1, 1979 to December 31, 1988) as well. They earned a return of 14.36% per year.

Is ten years long enough?
Financial advisors have said for years that stocks perform best over longer periods of time. They used to tell us that we should have at least five years before we needed the money or we shouldn’t invest in stocks. Now we’re hearing more and more that ten years is the magic number.

But here’s the thing … we really shouldn’t even count on that as we’ve learned the last ten years.

How long until you retire?
Let’s think about this … if you’re 40-years old, you might have twenty years before you want to retire. At 30, let’s say you have 30 years. How have the returns looked over that period?

Looking back twenty years, even with the most recent decade, our best bet would have been to be fully invested in stocks. Our return would have been 8.14% annually. It’s ditto for the most recent thirty years. An all-stock portfolio returned 10.21% per annum, about its historical average.

So, our research shows that history shows that you should stick with stocks over the long term. But is there a way to lower your risk without sacrificing returns unjustly?

The price of a higher return
There is a price to pay to get a higher return. That price is more volatility and volatility equals risk. Riskier investments should pay more to compensate you for the risk you’re taking. Stocks are riskier than CDs; therefore, they should pay more.

The price of less risk
We just said that riskier investments generally offer higher returns as compensation for the risk. So why not just invest in CDs and other risk-free assets? Because they may not return enough to get you where you need to go. There is a better answer.

Diversification smoothes it out
When you diversify your assets – investing part of your portfolio in risky assets like stocks and a portion in risk-free assets like CDs, you smooth out the volatility, relative to just investing in stocks, while still getting a higher return than if you invested all your money in just CDs.

Example: A 50/50 Mix

As we discussed earlier, had you just invested in stocks over the last thirty years, you would have made about 10 percent per year on your investment. However, you would have lost about one percent a year in the most recent decade.

What if you can’t stomach losses like that?

Obviously, any money invested in stocks is at risk. However, if we had invested 50 percent in stocks and 50 percent in CDs over the last thirty years:

  • We wouldn’t have lost money over the last decade. In fact, we would have made 1.31% per year.
  • The thirty-year return on our portfolio would have been 8.32% a year. While it’s less than the 10 percent we could have earned by just investing in stocks, it’s not that much less. Looks pretty good right now, doesn’t it?

We want to emphasize again that we’re not saying a 50/50 mix is right for you. Consult your financial planner. We just picked 50/50 to see what would have happened with an even mix of these two assets.

Long on stocks
As you can see from the returns we quoted earlier, the experts are right – stocks are good long term investments. If you need the money ten years from now, you need to be careful. If you’re a 30- or 40-year old funding your retirement, a good basket of stocks as part of a well-diversified portfolio is a great place to stick your money.

Short on dollars
Going back to where we started, more people are investing very conservatively in treasuries right now. The problem is, if you invest too conservatively, you have to make a choice. Will you be short on dollars now or at retirement?

If you choose to fully fund your retirement, it means you’ll have to invest more now to reach your goal, which means you’ll have to sacrifice more now than is probably necessary.

We still don’t know if we’ve hit bottom on the stock market. But here’s what we do know – most market timers get it wrong most of the time. That’s why we won’t try!

If you have time until you need the money, invest in a well-diversified portfolio. You won’t be quite as happy in the good times, but you won’t be nearly as upset during the bad. 

We really appreciate you spending some time with us today. Join us next time when we interview John Jantsch, The Duct Tape Marketer, about how to make customers stick without busting the bank. Until then, here’s to your bigg success!

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Are You Throwing Money Away by Owning Your Home?

toss_moneyWe all know that the three essentials for living are food, clothing, and shelter. We definitely rent our food. Do we rent or own our clothing? Hmmm.

Part of the American dream is to own your own home. And there are good reasons to do so. For instance, a Federal Reserve study[pdf] shows that the average family that owns a home has a net worth of nearly $625,000 while families who rent have a net worth of just a little over $54,000.

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Homeowners on the move

We’ve seen an interesting statistic bantered about, but we haven’t been able to pin down a reliable source. If this statistic is true, American homeowners move once every five years or so, on average.

So we thought we’d consider what that does to the buy vs. rent equation. We’ll use some averages and national statistics to create an example. However, what really matters is your own situation and your local real estate market. Only you, working with your financial advisors, can determine what’s in your best interest.

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marylynn When I was younger, one of my bosses in radio told me that I was just throwing away money by renting. I remember thinking that it made sense. I’d reached an age where maybe I should consider buying. So I did. As often happens in the radio business, less than a year later, I lost my gig. So I had to sell my house to move to a different market. I lost a lot of money by buying. If only I had had a crystal ball!

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Putting buy vs. rent to the test

We created a fictional purchase to see if we would be better off renting or owning a house for five years. We assumed that:

  • We put 20% down (approximately $63,000).
  • We financed the rest with a 30-year mortgage
  • The interest rate would be 6.50%, slightly above the current rate.
  • Our house would appreciate 4% per year, slightly below the recent average.
  • Property taxes would cost us 1% of the value of the home.
  • Insurance would run 0.50% of the value of the home. (Renters and homeowners have to insure the contents. We have the added burden of insuring the building.)
  • Repairs & maintenance would consume 1.50% of the value of the home.

Over the first five years, 83% of our total mortgage payments would go for interest. In other words, for the most part, we’ve traded renting property for renting money. If the interest rate is higher, the portion that would go to interest would also be higher. Of course, the reverse is also true.

During this period, we would pay $2,171 per month as “rental costs” for our home. We call them rental costs because they have no value once they’re paid. They only allow us to keep owning. So if we could rent a similar property for less than this, we would be better off renting instead of buying.

Of course, if we had made a down payment of less than $63,000, our cost would go up because we would be paying even more interest.

Where’s the break-even?

We also looked at how it would take before we would break-even. After all, it costs money to sell a house. We would have to pay commissions to our realtor, closing costs, and the like. We assumed these costs would total 8% of the selling price.

Given our assumptions, we looked at what would happen if we sold after one year. Our house would now be worth $326,560. From that, we would pay $26,125 in selling costs. After a year, our mortgage balance would be $248,392.

So we would be able to take out $52,043 in cash. But remember, we invested $63,000. So we lose about $11,000 if we sell after one year.

But that’s not the whole story …

We haven’t yet considered the opportunity cost of tying up that $63,000 in a house. Because if we didn’t invest it in this house, we could have invested in something else. We assumed we could have earned 6% by investing in some portfolio of financial assets.

That would have returned nearly $3,800. So by buying this house and selling it in a year, we would put ourselves in the hole nearly $15,000.

Even after 2 years, we’d still be about $3,500 behind, given our assumptions. Of course, one of those assumptions is that real estate prices are rising. It’s almost certain they will in the long run, but will they rise in the next year or two? They may not in some markets.

What’s the bottom-line?

We concluded that if we didn’t plan to own a house for at least two years, we’d rather rent. We also saw that the longer our holding period, the better we would do. For instance, in the last five years of the mortgage, only 15% of the mortgage payment would go to interest. It seems like buy-and-hold is rewarded in real estate investing.

How to get around it …

We have two friends who have been able to get around the short-term ownership problem. One of them is in the military, so he moves frequently. He only buys a house that he knows would make a good rental property. If he gets transferred, he hires a local property manager and rents it out. Until he decides where he wants to retire, he plans to hold a number of his houses.

Another friend doubled-down on this strategy. He moved quite frequently as he climbed the corporate ladder. Not only does he own houses in a number of cities, he bought additional rental properties, so he has a diversified portfolio across a number of cities. Now he’s retired living off the rents!

So you can get around the disadvantages of short-term ownership by having an alternative exit strategy!

Next time, we’ll discuss how a toy that you probably played with as a kid can help you manage your time. Until then, here’s to your bigg success!

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25 Ways to Have More Money at the End of the Month

By Bigg Success Staff
05-14-08

Bigg Success with Money 

twenty-five 

Here are links to five great articles that each offer five great tips to help you have more money at the end of the month. We’ve listed the five points for your perusal along with a link to the actual article.


5 Ways to Improve Your Credit Score

#1 – Get copies of your credit report and make sure the information is correct.

#2 – Pay your bills on time.

#3 – Understand how your credit score is determined.

#4 – Learn the legal steps you must take to improve your credit report.

#5 – Beware of credit report scams.

These five tips come from the Federal Reserve itself. Check out their detailed explanation of how to improve your credit score.

 

5 Tips to Commuting for Less

#1 – Calculate alternatives.

#2 – Improve your mileage.

#3 – Look to your employer.

#4 – Find a buddy.

#5 – Call your insurance company.

Get the full scoop on cutting your commuting costs at CNN Money. Gerri Willis did a great job with this timely article. And speaking of cutting your costs of commuting …

  

5 Ways to Find Cheap Gas

On your computer
#1 – Widgets

#2 – The interweb

On your phone
#3 – SMS text messages

#4 – Mobile web browser

In your car
#5 – GPS system

You can get all the details to find the best price for gas. LifeClever, the place that helps you design, work, and live better.

  

5 Tips for First Time Investors

#1 – Invest with small amounts of money.

#2 – Don’t invest what you can’t afford to lose.

#3 – Try not to let your emotions control you.

#4 – Be realistic.

#5 – Embrace your failures.

Adam Freedman wrote this fantastic post as a guest of the Silicon Valley Blogger. Check out all the full explanation of these great tips for first time investors.

And now some financial tips for all of us …

 

5 Simple Tips for Financial Success

#1 – Don’t pay interest on anything except your home mortgage and other investments.

#2 – No instant gratification.

#3 – Pay minimum income tax and invest the difference.

#4 – Raise financially independent children.

#5 – Convert your salary into securities and real estate.

These are rather self-explanatory, but you can get some more details on financial success at Squidoo.

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