Realism Required On Stock Returns


Gail Marks Jarvis is a columnist for the Chicago Tribune on financial matters. The Tribune recently combined their personal finance and real estate sections into one section, which seems to make sense.

Ms Marks Jarvis provides financial advice. In a column titled “Options About for IRA investors” she wrote the following:

Financial planners have not strayed from their usual advice for people in their 20s, 30s and 40s, despite the more than 50 percent decline in stocks and the subsequent 70 percent upturn.

If you have years to go before you retire, you are likely to make more money in stock funds than in CDs, said financial planner Gary Bowyer. On average, bonds gain 5.5 percent a year, while stocks return 9.4 percent. Although some years are awful, Bowyer said, gains close to the average are likely over 20 or 30 years.

The first and most crucial mis-characterization comes in the first paragraph; she mentions that stocks declined 50% with a subsequent 70% upturn. While this may technically be true, it will lead many people astray; it would SEEM that if you went down 50% and then up 70% you’d be “net” up 20% (70% – 50%) if you weren’t very good at math or didn’t pay attention to the subtleties of the market. However, it isn’t like that at all; if you have $100 and then it goes down 50% it goes to $50; a subsequent 70% rise means that now it is at $85, so you are still DOWN $15 (or 15% on your investment, ignoring the fact that you lost a year towards retirement that you can’t make up, which means that it is an even bigger loss than it appears).

I would agree that most “financial planners”, who make their living selling financial products, would tell you to keep on investing in stocks (mutual funds) and other types of products that earn them money; but it isn’t true that this is the advice that you will find out there at large nowadays (just keep putting money in stocks and it will be all right).

As far as stocks returning 9.4%, that is completely fanciful. Stocks have been DOWN for the last decade, and for it to return 9.4% you’d have to make up all that lost time plus the time value of money. Many planners are urging a much more conservative rate assumption than that. About the only people that use such high rates as assumptions are pension plans that are trying to avoid future cash infusions and yet pay out high payments to retirees.

There are many instances where the stocks aren’t regaining their past highs; look at the NASDAQ index which peaked at above 5,000 (5,132) but is now near 2400. The Japanese stock index (NIKKEI) peaked at 38,916 but is now near 10,800.

This is not to say that you shouldn’t invest in the stock market; but nowadays very few people would view it as sensible to assume such a high rate of return on stocks unless you discount the last decade or so plus the experiences of NASDAQ and the NIKKEI, among others. I also think that the 50% / 70% comparison is misleading to most investors.

Cross posted at LITGM

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