January 2, 2010
Friday, January 13, 2012
How to be a Better Saver
I am always looking for new tips and strategies on how to better spend -- and save -- my money. My co-teacher is extremely financially savvy and always has great resources to pass on. This article is definitely one of them and a must-read for all teachers (and everyone!):
January 2, 2010
January 2, 2010
It was the age of zeroes, the epoch of naughts, an era when we started with something and added just about nothing.
At least that’s what stock market commentators have been gravely telling us for at least a year. The 2000s, they argue, was a lost decade. And at first glance, they appear to have gotten it exactly right.
If you invested $100,000 on Jan. 1, 2000, in the Vanguard index fund that tracks the Standard & Poor’s 500, you would have ended up with $89,072 by mid-December of 2009. Adjust that for inflation by putting it in January 2000 dollars and you’re left with $69,114.
But that is not how most real people invest. They don’t pour everything they have into just one type of asset and then add nothing to it for 10 years. Instead, they buy stocks of all sorts, and bonds and perhaps other things, too. And many millions of them dutifully add more money regularly, usually into a retirement account that they won’t touch for longer than a decade.
For those people, it was not a lost decade at all. Even those who started with a low six-figure balance could have doubled their total savings in the last 10 years.
How? Consider a few decade-long scenarios that I asked Vanguard to run using its low-cost index mutual funds. In each, we assumed that the money was in a tax-deferred account and that the account owner reinvested any dividends.
First of all, even people who put all of their money in stocks rarely invest only in the big American names that make up the S.& P. 500.
So say you put $50,000 in the much broader Vanguard Total Stock Market Index Fund at the beginning of the decade. Then, for exposure to equities outside the United States, you put another $50,000 into Vanguard’s Total International Stock Index Fund.
As of mid-December, your $100,000 would have grown to $109,334, though that is just $84,921 when you take inflation into account. Still pretty dismal, though it shows the importance of diversification even within a broad category like stocks.
Now, consider a much more realistic scenario, with 50 percent of the money in bonds. If the decade begins with $25,000 in each of the domestic and international stock funds and $50,000 in Vanguard’s Total Bond Market Index Fund, you end it with $145,619, or $112,971 in 2000 dollars.
That’s how retirees, with a fairly aggressive 50 percent chunk of the portfolio in stocks, might have fared if they had been hoarding some investments while living mostly off Social Security and a pension or annuity. (For those who were spending down a portfolio with this aggressive allocation, there is no salve except the hope that what they have left will continue to bounce back.)
But if you’re not yet retired, you were probably adding money to your portfolio throughout the decade. Let’s say you started with the same $100,000 and the identical 25/25/50 asset allocation from the previous scenario. Now, imagine that you added $1,000 a month and then rebalanced your account annually so that you began each new year with that original allocation.
The result? You ended up with $313,747, or $260,102 in January 2000 dollars. Hardly a lost decade at all.
Your own balance may be much different from this. But if you’re moderately affluent, reasonably diligent and began the decade in your 30s or 40s (or were a bit older and got a late start in getting serious about retirement savings), this scenario won’t be that far off.
It’s easier to hit that $1,000 monthly saving if you have an employer matching some of your contributions. And consistent saving depends in large part on avoiding unemployment, which hasn’t been easy.
Even if your income continues uninterrupted, you can’t lose your nerve either. Plenty of people take their money out of stocks and put it into cash when the stock market falls. Then, they don’t put it back in until long after the recovery begins.
This can cost you whole percentage points in annual returns, which add up to hundreds of thousands of dollars over a lifetime. Indeed, investors in the hot fund of the moment will often earn returns way lower than the fund’s ads proclaim, though Vanguard index fund investors tend to be more of the slow and steady type.
And it’s that lifetime that’s important. The recent focus on the past decade’s performance is misguided for all sorts of reasons.
First of all, 10 years is not a particularly long time horizon. Retirement investors may begin saving at 22 and have money in stocks at 82. People who open 529 college savings accounts upon the birth of a child will keep them open for at least two decades and possibly longer.
A decade is a particularly short period of time for anyone who will need the money at the end of it. If that’s the case, the majority of it probably shouldn’t be in stocks in the first place, which would make the 10-year S.& P. 500 return less relevant.
Finally, this particular decade happened to start at an enormously overvalued moment. According to data from the Yale economist Robert J. Shiller, as of January 2000, the 10-year S.& P. 500 price-earnings ratio stood at 43.77, a month removed from its record high.
As a result, a lot of the lost decade hand-wringing is merely a result of this coincidence of the calendar. The 10-year performance figures may not look like such a lost decade a year or two from now, when the tally begins in 2001 or 2002 and the S.& P. 500 was at much lower levels.
The real danger in the lost-decade rhetoric is that it could scare people away from stocks permanently. Again, the long term is what matters to most stock investors. And according to Vanguard, the S.& P. 500’s worst 45-year run, for the period ending in September 1974, produced an average annual return of 6.53 percent.
Many of us could live with that, but stocks may not do even that well for the next 45 years. Near the stock market’s nadir in 2009, Robert D. Arnott of Research Affiliates scared a number of readers half to death by noting in an article in The Journal of Indexes that from February 1969 to February 2009, investors in 20-year Treasury bonds outperformed the S.& P. 500.
Stocks have since pulled ahead again, but Mr. Arnott’s larger point still stands — that the reward you’re supposed to get for the added risk of investing in stocks can seem awfully elusive in some contexts.
No one knows which asset class will outperform the others over the next 10 (or 45) years. That’s why it’s important to invest in more than just stocks, and why a bad stretch for certain stocks may not matter as much as it first appears.
Few of us have the long-term investing prowess to pick the right moment for the right stocks. But persistence has its own rewards. Savers are never losers, even if some stocks have let us all down in the short term.