The most frequent question I get asked as a Financial Planner is some variation of “What is the stock market going to do next?” It’s understandable that anyone would ask an “expert” this question and my response of how nobody can really know what is going to happen in the markets over the short or even intermediate term consistently and the stony faces I get from my reply always seems to indicate people think that I’m afraid of the question or more likely don’t know but should if I were any good. The problem with the question is the unthinking notion that being able to retire is a function of knowing when to get in the market, when to get out, when interest rates will change and the like. I submit that these items are unknowable and therefore irrelevant and that there are a great many other issues that can be addressed to insure we reach our financial goals.
If there was anything that I felt was most misunderstood and what concept would be the most helpful for investors to grasp and understand; unquestionably that would be: understanding what money is worth. Before you snort in disgust, understand that I’m talking about a long-term concept. It is practically un-American to think about almost anything in terms of decades and that goes double for our investment money. All of our life experience tells us one thing, but our short term vision blinds us to the lesson. Let me give you an example:
Say I showed you a chart that shows the result of investing $10,000 in 1980 in the broad US stock market (the S&P 500 index using a Vanguard fund). Most people can accept the final result: 10K at the end of 2009 had a lot of bumps along the way, but got an Average Annualized Return of 11.01% for a final market value of $229,203 (assuming we reinvested all dividends and capital gains and paid any taxes due out of another source.) It looks pretty good most would agree. We put in “only” 10K and got a big wad at the end!
Here’s my point: This person did NOT invest “only” $10,000 dollars to get this quarter million dollars we would have today. The mistake we all make is looking through the lens of “today”. We all have a feel for what 229K will buy us today. For me, that pays off the mortgage, buys a better car and takes the family on a nice trip and then the money is gone. But the mistake is to do the same type of thinking with the beginning investment of 10K. The initial investment looks kind of easy when we see the current pile we have now. What we are unconsciously doing is also thinking of what the initial 10K investment will buy TODAY, when the real trick is to understand what the 10K COULD have bought in 1980. The day the initial investment was made, a single first-class US postage stamp cost 0.15 cents. Today the very same stamp costs us 0.44 cents and I’ve heard it’s going up. That means the 10K we invested would have bought 66,666 stamps in 1980. If you brought 10K to the local post office today and thought you’d be able to get the same number of stamps you would have gotten in 1980, you would be very disappointed- we get only 22,727 stamps. The gradual rise in stamps (along with everything else) is called inflation. Everybody understands the concept but I’ve learned hardly anyone “gets” it in any practical way. From 1980 to the present, that gradual rise in stamp prices averages to 3.65% a year. The cost didn’t move every year, of course, but on average to get from .15 cents 30 years ago to .44 now, the price went up about 3.65% a year. What this means is that 10 grand in 1980 was not 10 grand today! Doing the math back-ward and expressing the initial investment back in 1980 in terms of what it would buy TODAY (again, that short-term focus we all live with) we get not $10,000 but $29,314.27. Did you do what I did when I first saw this scenario? I thought: “Putting only 10k away got me all that?” When I put it in real terms of 30K, it’s not as exciting.
Surprised? You shouldn’t be. Anyone at least my age will recognize this phenomenon is almost every area of their life, if we put our blackberries down for a few minutes of reflection. Remember buying your first car? What gas used to cost? Dinner out with your high-school girlfriend? I asked my Dad to reflect, and he told me his memory of using a rule of thumb when he was first married that a bag of groceries was on average $5/bag. Try and do most anything today with the same number of dollars you did a decade ago and you’ll see what I mean.
One of the things I love best about my fellow countrymen is the continual push to move forward. The flipside of my irritation with investors that can’t be bothered with the past is that they have contagious enthusiasm for the future and don’t want to get mired in the past. I’m all for that! Let’s look at the future: According to 401kplanning.org, the median household balance of all retirement accounts for people aged 55-64 is $100,000 in 2007. Let’s assume for a moment that the next 25 years produces the same return as my earlier example: 100K invested 25 years getting an average annual return of 11% will give us $1,358,546. Remove those dollar signs from your eyes! See how hard it is to not think about future money in terms of what it will buy today? If the stamp analogy continues, and the price of everything goes up by 3.65% every year, then “today’s equivalent value” of the investment at the end of 25 years is $509,613. But of course that assumes you reinvest all the gains along the way and never spend anything. Taking a $5000/year draw each year that increases every year for 25 years to keep up with the rise of the price of stamps leaves you at the end with $205,329 in todays money.
But what if returns are not as good going forward? What if inflation is higher or lower? What if I really want to leave something for my kids? What if I need more income than that? What if I put away more every month? These are all good questions and can actually be addressed by asking a good Financial Advisor. That’s what financial planning is all about! Or you can go back to asking what the Gold is going to do this quarter.