Investing 101: Accumulating the First Million How, Where, and When
October, this is one of the peculiarly dangerous months to speculate in stocks. The others are July, January September, April, November, May, March, June, December, August and February. Mark Twain, 1899.
The most powerful force in the universe is compound Interest. • Albert Einstein
Historical Returns Stocks Bonds CD’s Avg. 10% 5% 3% Min. -66% (1932) -9% 0% Max. 155%(1933) 40.3% 15%
Value of Crystal Ball Timing Buy and Hold Jan. 1926 $1,000 $1,000 Sept. 1929 $3,633 $2,541 July 1932 $9,502 $415 Jan. 1945 $1,076,709 $2,549 July 2000 $7 Trillion $2,145,679 Dec. 2002 $11.7 Trillion $1,273,690 Dec. 2004 $19.2 Trillion $1,847,619
Before running down to the local fortune teller/stockbroker… • Since 1960, if you had invested $1,000 in the Stock Market, it would now be worth $82,680. • If you did time the market correctly every time, it would be worth $331,673,980. • However, if you had your money in the bank during just the top 10% stock performing months, you would only be worth $1,465; missed top 5%: $7,547; only missed top 2%: $24,511. • Lesson – More fortunes are lost than made when investors think they know when the market is going up or down.
How Long Will it Take? • CDs, Checking accounts – 71 years • T-bonds – 56 years • General Stock fund – 36 years averaging 10% a year. Investing $3,000 a year…
Alternatives I Don’t Have That Long! • Invest more! Don’t have more? Could take on more risk… • China, India, and other developing countries. • Could see 12 to 15% average gains over next 20 years • $3,000 a year would be worth $1 million in approximately 22 to 25 years. • On the other hand, one or more of these International Company’s CEOs or governments thanks you for your $3,000 a year donation.
Alternatives Maybe I Don’t Need That Much! • Maybe not. How can you tell? • Step 1: Estimate how much you will need. Most planners suggest at least 80% of what you spend now. Multiply that by 1.03 (3% is from average inflation rate) to the nth power where n is the number of years until retirement. Ex. Earn $50,000, Save $5,000. 80% of $45,000 = $36,000. Can further reduce number by expected TCRS payment and/or Social Security if it still exists. Let’s assume $12,000 in other payments. • Assume 25 years to retirement, will need $24,000 * 1.03^25 = $50,251 per year.
Know how much you do need, you might need even more. • Step 2: To have a 90% chance or more of not running out of money, should only withdraw 5% a year. Thus, divide amount needed each year by 0.05. Our example, $50,251/0.05 = $1,005,013. Looks like you do need a Million! • Step 3: Don’t panic. Spaghetti is still relatively inexpensive if combined with the generic sauce. You won’t starve, but you may have to cut back more than you think if don’t plan ahead.
Other Alternatives • Don’t put all your money in the “typical” S&P 500 index fund. Why? Too many institutions with too much money chasing too few stocks. • Small cap stocks generally outperform. • Invest in Index funds, but make the index the Wilshire 5000 or what is usually called an extended equity fund. Average company size is $2 billion vs $20+ billion in the S&P 500. • Could boost returns by 2% or so. So what? Difference between 10% and 12% over 20 years is $50,000. Over 30 years is $250,000 based on $3,000 a year contributions. • Spreadsheet scenario analysis
How about if I just invest in one company? • Sure, you might get lucky…$3,000 in Cisco in 1990 would have been worth $2,825,524 in 2000, it’s still worth $625,536 today.
On the other hand… • GM in 1990 was selling for $45, it’s now selling for $10, and this is/was a good company! theglobe.com, E-toys, …, you could have done much worse.
What about JDS Uniphase! • At one time, it was worth over $90 billion and battling Microsoft and GE for the title of the largest company in the world.
Not just correct on the farm, “Don’t put all your eggs in one basket!” • With over 8,000 publicly traded companies, we could keep trying. However, investing in only one company is not a good idea for retirement investing. Just ask any Worldcom, Enron, Global Crossing, Adelphia, Lucent, etc. investors.
Advice. • It takes time. If you have limited time, invest more wealth in an asset mix appropriate for your time horizon and risk aversion. • Do not try to shorten the time to reach your “Millions” by just taking on more risk. This increases the probability you will fall short. • Example, 100% in stocks, 10% chance you will end up with less than $215,000 in 36 years. With a 60/40 stock/bond portfolio, only a 10% chance you will end up with less than $600,000.
Specifics • Bare basic essentials… • Invest in an extended equity index fund, an international fund, and in a mid-grade or high yield bond fund. Generic ratios are 55%, 25%, and 20%. This is an aggressive portfolio. • Based on risk tolerances and age to retirement, you likely will have to adjust these ratios but knowing nothing about each individual’s circumstances, this is what I would recommend. Assuming at least 15+years to retirement. • Only 10 years, 50%, 20%, and 30% with a greater use of mid-grade corporate bonds and world income funds in the last percentage. Keep in mind, even after you retire, you likely will still have a 20+ year time horizon.
Is there an easier way so I can do something else in life? • Target Date Mutual Funds • Pick the date you plan to retire, the mutual fund automatically sets the initial asset allocation and adjusts it towards a less risky position as you approach retirement. ETSU already offers these funds and you reduce your taxable income at the same time. Thus, each $1 you invest may only cost you $0.75 depending on your income tax bracket. • ETSU matches the first $50 a month. If you do nothing else, invest at least $50 a month, you make an immediate 100% return.
Target Date Funds in ETSU’s 457 and 401k plans • Vanguard 2010 to 2050, Asset Composition Percentages
Let’s Try A Simulation • Only have 25 minutes. Here’s your chance to accumulate your first million! • Link