|The 10% Myth|
|Written by John D. Buerger, CFP®|
|Monday, 03 May 2010 14:40|
Did you ever tell somebody that Santa Claus doesn't exist?
I mean, it is the truth and all and we all find out about it in some way, but were you ever the one to deliver the news straight out?
That is the role I get to play today - but this reality check isn't about Santa Claus. It is about something that makes people feel almost as good, though. This myth revolves around your money and the kinds of returns you can expect out of many years invested in the stock market.
I call it the 10% Myth and it goes something like this:
The Stock Market has, on average, made about 10% returns.
Although promoters of this myth never say it (that would be illegal - past results are no indication of future performance), the message most people hear is:
Invest in stocks today, and YOU can make 10% returns, too!
This is usually followed up with wet-noodle scolding by the stock broker if you happen to own bonds, CD's or (God-forbid) annuities. Why would you want to get a measly 4-5% return, when you can have 10%. You'll double your money faster with stocks (7 years as opposed to 15). You'll be rolling in the dough. You can retire early!!! Just take a little risk!
Can you feel the dopamine rush starting to cascade from your brain as you anticipate finally getting out of the rat race and living the high life? It feels really good! And all you need to make it happen is some stocks and a long enough time-table to mitigate the risk (another myth for a later day).
No Virginia, There Is No Santa Claus
(At least, not on Wall Street)
It would be great ... but it simply is not true, at least not consistently.
Sure, there have been 10-year (and even a few 20-year) periods where the stock market has done better than 10%. We went back (to 1896) and looked at all the data on the Dow 30 Industrials and found out that the market did better than 10% returns (before inflation) about 22% of the time. When you look at 20-year periods, a long term 10% return happened only 10% of the time.
So maybe there is a Santa Claus, but he only shows up on one out of every 10 Christmas Eves.
There are probably some stock brokers who are devout Santa peddlers who will point out that this data does not include dividends and true, it does not. This data also does not include inflation which counters the dividend effect. But even if you include a generous dividend effect of 3% and still ignore inflation, the 10% story is only true one third of the time.
The Real Number - 7%
So if the equities markets are NOT generating 10% rates of return, what is the truth?
The real number (before inflation) is pretty close to 7% ... and that is over the history of the stock market. We crunched the data for the Dow Jones 30 since 1896 and the S&P 500 since 1928. It didn't really matter which index we used or even when we started or stopped. Once you get out to 40-50 years (longer than you or I will be investing), the average rate of return is the equivalent to buying a CD with a 7% interest payment ...
... but with a boatload more risk.
I am telling you this for one reason and one reason only - I want you to know the truth.
When you can get your head around 7% (not 10%) as being a reasonably accurate estimate of how quickly your money can grow (and THAT is still by taking on a whole lot of risk), it might change how you view each of your options for getting a return on your investments.
Knowing that equities earn, on average 7% (including dividends but before inflation), you might make smarter choices with your money.
Millions of Americans were heavily invested in equities within 5-10 years of retirement. When their portfolios blew up in 2008 they were faced with a new choice: "Keep working 5-10 more years longer than I planned" or "Enjoy a severely diminished lifestyle for the rest of my life."
They were faced with that choice because they were NOT aware of the risks they were taking with their investments. All they could see were those 10% returns they wanted to get. It didn't help that the previous 10 and 20 year cycles HAD seen 10% returns. That just made them more willing to believe the myth and plan their finances accordingly.
What Now? - Solutions
I present issues (problems, threats, etc.) like this because you need to be aware that they are out there. Going through life blissfully ignorant of risk is a recipe for disaster. You don't walk out into a snow storm without a jacket, boots and gloves. Don't walk into a hostile investment environment unprepared, either.
What are the preparations you should make?
(a) Build Wealth Through Cash Flow - Striving for 10% returns comes with a tremendous amount of downside risk. Aim lower. Shoot for inflation plus 4 or inflation plus 5 and you're far more likely to hit it. That will likely mean that you will need to save more and spend less. That's not such a bad idea, anyway. You can build a lot more wealth more quickly through cash flow management than you can through any investment strategy. Ask me about our Cash Flow Hydrant™ cash management tool.
(b) Diversify across broad asset classes - A portfolio of 500 US stocks is well diversified (you own 500 different companies), but it is not diversified across asset classes. Buy stocks, bonds and commodities. Spread your investments as much as you can across the globe. Buy local, international and even developing markets. A globally diversified portfolio started in early 2008 is actually up 10-15% from where it started. The S&P 500 is down 10%. Real estate is down 35%.
(c) Don't be afraid of other types of investment vehicles - There is a place in your life for insurance products like annuities and cash value life insurance when they are structured properly. Mind you, insurance products are "sold" and agents are paid commissions. Be careful. Most of the time, the product is constructed in such a way to benefit the agent more than the client. That doesn't make the product bad ... it just means you may be buying a lot of stuff you don't need.
(d) Learn about more advanced strategies - IF you already understand and have implemented a globally diversified portfolio using low cost index ETF's and mutual funds (most portfolios I review for new clients are not even advanced to this level), then you can start learning about options and futures strategies to improve returns while eliminating risk.
No More Santa Peddlers
The 10% Myth was originally promoted by the big stock brokerage firms. If your stock broker, money manager or "financial advisor" promotes the 10% Myth ... it's time for a new relationship with a different advisor. You might start with a fiduciary advisor who holds themselves to the ethical responsibility to do what is YOUR best interests first. You also might want to work with someone who understands strategies that are a little more sophisticated than "buy stocks for the long haul."
My last suggestion is usually my first suggestion:
STAY AWAY FROM FINANCIAL PORNOGRAPHY
The financial media are all peddling something - advertisements. Those ads are being paid for by the big stock brokerage firms. Every time you see Jim Cramer pound the table telling you to "Buy, Buy, Buy" he is only doing what he can to get you to generate a financial product transaction. It is that transaction that puts profits into the brokerage companies which, in turn, pays for the advertising which, in turn, pays Jim Cramer's salary.
He has no fiduciary duty to you.
The financial pornography business is all about titillation - They want you to feel that dopamine rush in anticipation of huge gains you hope to get (because they show you how everybody else is getting them - even when they're not). What you see on CNBC and MSNBC and Bloomberg News is theater ... designed to excite you and get you to think emotionally about your investments. But emotions are the reason most investors under perform the market by 6-7% (Dalbar studies).
The next time you see Jim Cramer pound the desk and yell, "Buy, Buy, Buy!" turn off the TV and tell him, "Bye, Bye, Bye!"
Then go watch a movie like "Miracle on 42nd Street." It's still a myth, but it is a lot less dangerous to your financial future.
|Last Updated on Monday, 03 May 2010 23:35|